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Substitution and Risk Aversion: Is Risk Aversion Important for Understanding Asset Prices?

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Author Info
Benjamin Eden () (Department of Economics, Vanderbilt University)

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Abstract

This paper uses a recursive time-non-separable expected utility function to separate between the intertemporal elasticity of substitution (IES) and a measure of relative risk aversion to bets in terms of money (RAM). Risk premium does not require risk aversion. Changes in IES have large effects on asset prices but changes in risk aversion have only a small effect on asset prices. Assuming IES = 1 and allowing a wide range for the RAM coefficient (say between 0 and 10) is consistent with the cross-countries observation made by Lucas (2003) and the net of taxes and net of frictions rates of return estimated by McGrattan and Prescott (2003).

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File URL: http://www.vanderbilt.edu/Econ/wparchive/workpaper/vu04-w22.pdf
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File Function: First version, 2004
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Publisher Info
Paper provided by Department of Economics, Vanderbilt University in its series Working Papers with number 0422.

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Date of creation: Nov 2004
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Handle: RePEc:van:wpaper:0422

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Related research
Keywords: Asset pricing; intertemporal elasticity of substitution; risk aversion;

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

This paper has been announced in the following NEP Reports:

References listed on IDEAS
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  1. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April. [Downloadable!] (restricted)
    Other versions:
  2. Christian Gollier, 2004. "The Economics of Risk and Time," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572249.
  3. David Backus & Bryan Routledge & Stanley Zin, 2004. "Exotic Preferences for Macroeconomists," Working Papers 04-20, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
    Other versions:
  4. Eden, Benjamin, 1977. "The role of insurance and gambling in allocating risk over time," Journal of Economic Theory, Elsevier, vol. 16(2), pages 228-246, December. [Downloadable!] (restricted)
  5. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 29-42, February. [Downloadable!] (restricted)
  6. Deaton, Angus & Paxson, Christina, 1994. "Intertemporal Choice and Inequality," Journal of Political Economy, University of Chicago Press, vol. 102(3), pages 437-67, June. [Downloadable!] (restricted)
    Other versions:
  7. Levhari, David & Srinivasan, T N, 1969. "Optimal Savings under Uncertainty," Review of Economic Studies, Blackwell Publishing, vol. 36(106), pages 153-63, April. [Downloadable!] (restricted)
  8. John Y. Campbell & N. Gregory Mankiw, 1990. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  9. Ellen R. McGrattan & Edward C. Prescott, 2003. "Average debt and equity returns: puzzling?," Staff Report 313, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  10. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March. [Downloadable!] (restricted)
  11. Gadi Barlevy, 2005. "The cost of business cycles and the benefits of stabilization," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 32-49. [Downloadable!]
  12. Tjalling C. Koopmans, 1959. "Stationary Ordinal Utility and Impatience," Cowles Foundation Discussion Papers 81, Cowles Foundation, Yale University. [Downloadable!]
  13. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November. [Downloadable!] (restricted)
  14. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July. [Downloadable!] (restricted)
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