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Can risk aversion explain stock price volatility?

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  • Stephen F. LeRoy

Abstract

Why are the prices of stocks and other assets so volatile? Efficient capital markets theory implies that stock prices should be much less volatile than actually observed, reflecting an unrealistic assumption that investors are risk neutral. If instead investors are assumed to be risk averse, predicted volatility is higher. However, models that incorporate investor avoidance of risk can explain real-world stock price volatility only under levels of risk aversion that are unrealistically high. Thus, price volatility remains unexplained.

Suggested Citation

  • Stephen F. LeRoy, 2013. "Can risk aversion explain stock price volatility?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue apr8.
    • Handle: RePEc:fip:fedfel:y:2013:i:apr8:n:2013-10
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    References listed on IDEAS

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    1. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-436, June.
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    Cited by:

    1. Michele Vodret & Iacopo Mastromatteo & Bence Tóth & Michael Benzaquen, 2023. "Microfounding GARCH models and beyond: a Kyle-inspired model with adaptive agents," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 18(3), pages 599-625, July.

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    Stock - Prices;

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