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Risk-free rate puzzle: An explanation of the heterogeneity of consumer risk attitudes under China's income gap

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  • Zhao, Yang
  • Yao, Yuan
  • Wang, Mingtao

Abstract

The original C-CAPM encounters a risk-free rate puzzle, making it difficult for the capital and consumer markets to achieve equilibrium. This problem can be addressed by solving this risk-free rate puzzle. In this paper, we propose that a representative consumer in the C-CAPM does not reflect the reality of China's social development. Second, we introduce three kinds of typical consumers, low-, middle- and high-income consumers, to embody the heterogeneity of risk attitudes. From the perspective of the consumer Pareto optimum, we derive the new C-CAPM and risk-free rate equation. Third, we compare the new model with the original C-CAPM and risk-free rate equation and theoretically explain this equation. Using monthly data on social consumption in China from 2011 to 2019, we find that the income gap in China is the underlying reason for this risk-free rate puzzle.

Suggested Citation

  • Zhao, Yang & Yao, Yuan & Wang, Mingtao, 2024. "Risk-free rate puzzle: An explanation of the heterogeneity of consumer risk attitudes under China's income gap," International Review of Economics & Finance, Elsevier, vol. 89(PB), pages 940-960.
    • Handle: RePEc:eee:reveco:v:89:y:2024:i:pb:p:940-960
    DOI: 10.1016/j.iref.2023.10.039
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    More about this item

    Keywords

    Risk heterogeneity; Consumer groups; Risk-free rate puzzle; The capital asset pricing model;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth
    • D19 - Microeconomics - - Household Behavior - - - Other

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