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Asset Returns and State-Dependent Risk Preferences

Author

Listed:
  • Gordon S.
  • St-Amour P.

Abstract

We propose a consumption-based capital asset pricing model in which the representative agent's preferences display state-dependent risk aversion. We obtain a valuation equation in which the vector of excess returns on equity includes both consumption risk as well as the risk associated with variations in preferences. We develop a simple model that can be estimated without specifying the functional form linking risk aversion with state variables. Our estimates are based on Markov chain Monte Carlo estimation of exact discrete-time parameterizations for linear diffusion processes. Since consumption risk is not forced to account for the entire risk premium, our results contrast sharply with estimates from models in which risk aversion is state-independent. We find that relaxing fixed risk preferences yields estimates for relative risk aversion that are (i) reasonable by usual standards, (ii) correlated with both consumption and returns and (iii) indicative of an additional preference risk of holding the assets. Nous suggérons un modèle d'équilibre de prix des actifs où les préférences de l'agent représentatif sont caractérisées par une aversion contingente au risque. Nous obtenons une équation de valorisation où la prime de risque dépend du risque de préférences en plus du risque de consommation habituel. Nous développons une application empirique qui ne nécessite pas une forme fonctionnelle reliant l'aversion non-observable à des variables économiques observables. Nos estimations sont basées sur une estimation en chaîne markovienne de Monte-Carlo pour des vraisemblances exactes de processus linéaires de diffusion appliquées aux données en temps discret. Puisque le risque de consommation n'a plus à justifier seul la forte prime de risque observée sur les fonds propres, nos estimations contrastent fortement avec celles obtenues dans le cas standard où l'aversion au risque est constante. En particulier, nous trouvons des estimés de l'aversion au risque qui sont (i) de ni
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Suggested Citation

  • Gordon S. & St-Amour P., 2004. "Asset Returns and State-Dependent Risk Preferences," Journal of Business & Economic Statistics, American Statistical Association, vol. 22, pages 241-252, July.
  • Handle: RePEc:bes:jnlbes:v:22:y:2004:p:241-252
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    Cited by:

    1. TAKAMIZAWA, Hideyuki, 2018. "An Equilibrium Model of Term Structures of Bonds and Equities," Working Paper Series G-1-19, Center for Financial Research, Graduate School of Commerce and Management, Hitotsubashi University.
    2. Tim Bollerslev & George Tauchen & Hao Zhou, 2009. "Expected Stock Returns and Variance Risk Premia," Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4463-4492, November.
    3. Bollerslev, Tim & Gibson, Michael & Zhou, Hao, 2011. "Dynamic estimation of volatility risk premia and investor risk aversion from option-implied and realized volatilities," Journal of Econometrics, Elsevier, vol. 160(1), pages 235-245, January.
    4. Angelo Melino & Alan X. Yang, 2003. "State Dependent Preferences Can Explain the Equity Premium Puzzle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 806-830, October.
    5. Bekaert, Geert & Engstrom, Eric & Grenadier, Steven R., 2010. "Stock and bond returns with Moody Investors," Journal of Empirical Finance, Elsevier, vol. 17(5), pages 867-894, December.
    6. Danthine, Jean-Pierre & Donaldson, John B. & Giannikos, Christos & Guirguis, Hany, 2004. "On the consequences of state dependent preferences for the pricing of financial assets," Finance Research Letters, Elsevier, vol. 1(3), pages 143-153, September.
    7. Traian A. Pirvu & Huayue Zhang, 2012. "A Multi Period Equilibrium Pricing Model," Papers 1205.6193, arXiv.org.
    8. Luz Rocío Sotomayor & Abel Cadenillas, 2009. "Explicit Solutions Of Consumption-Investment Problems In Financial Markets With Regime Switching," Mathematical Finance, Wiley Blackwell, vol. 19(2), pages 251-279.
    9. Martin Lettau & Sydney Ludvigson, 2009. "Euler Equation Errors," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(2), pages 255-283, April.
    10. Sei-Wan Kim & Bong-Soo Lee, 2008. "Stock Returns, Asymmetric Volatility, Risk Aversion, And Business Cycle: Some New Evidence," Economic Inquiry, Western Economic Association International, vol. 46(2), pages 131-148, April.
    11. repec:eee:jfinec:v:128:y:2018:i:3:p:504-534 is not listed on IDEAS
    12. Gandelman, Néstor & Hernández-Murillo, Rubén, 2013. "What do happiness and health satisfaction data tell us about relative risk aversion?," Journal of Economic Psychology, Elsevier, vol. 39(C), pages 301-312.
    13. Ricardo M. Sousa, 2007. "Wealth Shocks and Risk Aversion," NIPE Working Papers 28/2007, NIPE - Universidade do Minho.
    14. Maneesoonthorn, Worapree & Martin, Gael M. & Forbes, Catherine S. & Grose, Simone D., 2012. "Probabilistic forecasts of volatility and its risk premia," Journal of Econometrics, Elsevier, vol. 171(2), pages 217-236.
    15. John Donaldson & Rajnish Mehra, 2007. "Risk Based Explanations of the Equity Premium," NBER Working Papers 13220, National Bureau of Economic Research, Inc.
    16. Paulo Maio, 2013. "Intertemporal CAPM with Conditioning Variables," Management Science, INFORMS, vol. 59(1), pages 122-141, April.
    17. Gandelman, Nestor & Hernandez-Murillo, Ruben, 2015. "Risk Aversion at the Country Level," Review, Federal Reserve Bank of St. Louis, vol. 97(1), pages 53-66.
    18. Alan Guoming Huang & Eric Hughson & J. Chris Leach, 2016. "Generational Asset Pricing, Equity Puzzles, and Cyclicality," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 22, pages 52-71, October.
    19. Andrei Semenov, 2017. "Background risk in consumption and the equity risk premium," Review of Quantitative Finance and Accounting, Springer, vol. 48(2), pages 407-439, February.
    20. Andrei Semenov, 2003. "High-Order Consumption Moments and Asset Pricing," Working Papers 2003_4, York University, Department of Economics, revised Jan 2005.
    21. Wu, Feng & Myers, Robert J. & Guan, Zhengfei & Wang, Zhiguang, 2015. "Risk-adjusted implied volatility and its performance in forecasting realized volatility in corn futures prices," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 260-274.
    22. Till Strohsal, 2013. "Testing the Preferred-Habitat Theory: The Role ofTime-Varying Risk Aversion," SFB 649 Discussion Papers SFB649DP2013-043, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    23. Andrei Semenov, 2004. "High-Order Consumption Moments and Asset Pricing," 2004 Meeting Papers 334, Society for Economic Dynamics.
    24. Reyno SEYMORE & Margaret MABUGU & Jan VAN HEERDEN, "undated". "Border Tax Adjustments to Negate the Economic Impact of an Electricity Generation Tax," EcoMod2010 259600155, EcoMod.
    25. Dominique Pepin, 2011. "Instabilité des comportements et cycles financiers : une relecture dans un cadre rationnel avec préférences endogènes," Working Papers hal-00960012, HAL.

    More about this item

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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