IDEAS home Printed from https://ideas.repec.org/a/eee/finlet/v1y2004i3p143-153.html
   My bibliography  Save this article

On the consequences of state dependent preferences for the pricing of financial assets

Author

Listed:
  • Danthine, Jean-Pierre
  • Donaldson, John B.
  • Giannikos, Christos
  • Guirguis, Hany

Abstract

This Paper introduces state dependent utility into the standard Mehra and Prescott (1985) economy by allowing the representative agent’s coefficient of relative risk aversion to vary with the underlying economy’s growth rate. Existence of equilibrium is proved and its asymptotic properties analysed. This generalization leads to level dependent marginal rates of substitution, a property that sharply distinguishes this model from the standard construct. For very low coefficients of relative risk aversion, the equilibrium risk free and risky security returns are demonstrated to have volatilities and an associated equity premium that substantially exceed what is found in the data. This provides a contrasting perspective on the classic ‘equity premium puzzle.’
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • 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.
    • Handle: RePEc:eee:finlet:v:1:y:2004:i:3:p:143-153
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1544-6123(04)00042-X
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    2. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
    3. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    4. 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.
    5. 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 937-969, July.
    6. 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.
    7. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
    8. Mehra, Rajnish & Sah, Raaj, 2002. "Mood fluctuations, projection bias, and volatility of equity prices," Journal of Economic Dynamics and Control, Elsevier, vol. 26(5), pages 869-887, May.
    9. Falato, Antonio, 2009. "Happiness maintenance and asset prices," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1247-1262, June.
    10. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-543, June.
    11. 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.
    12. Nygren, Thomas E. & Isen, Alice M. & Taylor, Pamela J. & Dulin, Jessica, 1996. "The Influence of Positive Affect on the Decision Rule in Risk Situations: Focus on Outcome (and Especially Avoidance of Loss) Rather Than Probability," Organizational Behavior and Human Decision Processes, Elsevier, vol. 66(1), pages 59-72, April.
    13. Isen, Alice M. & Geva, Nehemia, 1987. "The influence of positive affect on acceptable level of risk: The person with a large canoe has a large worry," Organizational Behavior and Human Decision Processes, Elsevier, vol. 39(2), pages 145-154, April.
    14. Bosch-Domenech, Antoni & Silvestre, Joaquim, 1999. "Does risk aversion or attraction depend on income? An experiment," Economics Letters, Elsevier, vol. 65(3), pages 265-273, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. 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.
    2. 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.
    3. Falato, Antonio, 2009. "Happiness maintenance and asset prices," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1247-1262, June.
    4. Pascal St-Amour, 2004. "Ratchet vs Blasé Investors and Asset Markets," CIRANO Working Papers 2004s-11, CIRANO.
    5. Felix Kubler & Karl Schmedders, 2010. "Non-parametric counterfactual analysis in dynamic general equilibrium," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 45(1), pages 181-200, October.
    6. Miroslav Misina, 2003. "What does the risk-appetite index measure?," Economics Bulletin, AccessEcon, vol. 28(6), pages 1-6.
    7. Miroslav Misina, 2005. "Risk Perceptions and Attitudes," Staff Working Papers 05-17, Bank of Canada.
    8. Dominique Pepin, 2011. "Instabilité des comportements et cycles financiers : une relecture dans un cadre rationnel avec préférences endogènes," Working Papers hal-00960012, HAL.
    9. Kraus, Alan & Sagi, Jacob S., 2006. "Asset pricing with unforeseen contingencies," Journal of Financial Economics, Elsevier, vol. 82(2), pages 417-453, November.
    10. Traian A. Pirvu & Huayue Zhang, 2012. "A Multi Period Equilibrium Pricing Model," Papers 1205.6193, arXiv.org.
    11. John Donaldson & Rajnish Mehra, 2007. "Risk Based Explanations of the Equity Premium," NBER Working Papers 13220, National Bureau of Economic Research, Inc.
    12. Jaime A. Londo~no, 2006. "State Dependent Utility," Papers math/0603316, arXiv.org.

    More about this item

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finlet:v:1:y:2004:i:3:p:143-153. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/frl .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.