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Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices

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  • Bonomo, Marco
  • Garcia, René
  • Meddahi, Nour
  • Tédongap, Roméo

Abstract

We propose an asset pricing model where preferences display generalized disappointment aversion (Routledge and Zin, 2009) and the endowment process involves long-run volatility risk. These preferences, which are embedded in the Epstein and Zin (1989) recursive utility framework, overweight disappointing results as compared to expected utility, and display relatively larger risk aversion for small gambles. With a Markov switching model for the endowment process, we derive closed-form solutions for all returns moments and predictability regressions. The model produces first and second moments of price-dividend ratios and asset returns and return predictability patterns in line with the data. Compared to Bansal and Yaron (2004), we generate: i) more predictability of excess returns by price-dividend ratios; ii) less predictability of consumption growth rates by price-dividend ratios. Differently from the Bansal and Yaron model, our results do not depend on a value of the elasticity of intertemporal substitution greater than one.

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Bibliographic Info

Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 10-187.

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Date of creation: Jun 2010
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Publication status: Published in The Review of Financial Studies, vol.�24, n°1, 2011, p.�82-122.
Handle: RePEc:tse:wpaper:23194

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Cited by:
  1. Ang, Andrew & Timmermann, Allan G, 2011. "Regime Changes and Financial Markets," CEPR Discussion Papers 8480, C.E.P.R. Discussion Papers.
  2. Monfort, A. & Pegoraro, F., 2012. "Asset Pricing with Second-Order Esscher Transforms," Working papers 397, Banque de France.
  3. Stanislav Khrapov, 2012. "Risk Premia: Short and Long-term," Working Papers w0169, Center for Economic and Financial Research (CEFIR).
  4. Bakshi, Gurdip & Chabi-Yo, Fousseni, 2011. "Variance Bounds on the Permanent and Transitory Components of Stochastic Discount Factors," Working Paper Series 2011-11, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  5. Pagel, Michaela, 2012. "Expectations-Based Reference-Dependent Preferences and Asset Pricing," MPRA Paper 47933, University Library of Munich, Germany.
  6. Jianjian Jin, 2013. "Jump-Diffusion Long-Run Risks Models, Variance Risk Premium and Volatility Dynamics," Working Papers 13-12, Bank of Canada.

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