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Rational Ignorance in Long-run Risk Models

Author

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  • Stefano d¡¦Addona

    (University of Roma Tre, Italy)

Abstract

This paper documents an unpleasant feature of Epstein-Zin preferences in long-run risk models that are widespread in asset pricing: Agents with a preference for an early resolution of uncertainty achieve higher utility if they ignore information on the state of the business cycle.

Suggested Citation

  • Stefano d¡¦Addona, 2018. "Rational Ignorance in Long-run Risk Models," International Journal of Business and Economics, School of Management Development, Feng Chia University, Taichung, Taiwan, vol. 17(1), pages 43-54, June.
  • Handle: RePEc:ijb:journl:v:17:y:2018:i:1:p:43-54
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    References listed on IDEAS

    as
    1. Lars Peter Hansen, 2007. "Beliefs, Doubts and Learning: Valuing Macroeconomic Risk," American Economic Review, American Economic Association, vol. 97(2), pages 1-30, May.
    2. Riccardo Colacito & Mariano M. Croce, 2011. "Risks for the Long Run and the Real Exchange Rate," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 153-181.
    3. Martin Lettau & Sydney C. Ludvigson & Jessica A. Wachter, 2008. "The Declining Equity Premium: What Role Does Macroeconomic Risk Play?," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1653-1687, July.
    4. Kocherlakota, Narayana R, 1990. " Disentangling the Coefficient of Relative Risk Aversion from the Elasticity of Intertemporal Substitution: An Irrelevance Result," Journal of Finance, American Finance Association, vol. 45(1), pages 175-190, March.
    5. Massimiliano Croce, Mariano, 2014. "Long-run productivity risk: A new hope for production-based asset pricing?," Journal of Monetary Economics, Elsevier, vol. 66(C), pages 13-31.
    6. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
    7. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-396, March.
    8. 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.
    9. Taeyoung Doh, 2013. "Long‐Run Risks In The Term Structure Of Interest Rates: Estimation," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 28(3), pages 478-497, April.
    10. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, August.
    11. Bansal, Ravi & Kiku, Dana & Yaron, Amir, 2012. "An Empirical Evaluation of the Long-Run Risks Model for Asset Prices," Critical Finance Review, now publishers, vol. 1(1), pages 183-221, January.
    12. Lars Peter Hansen & John C. Heaton & Nan Li, 2008. "Consumption Strikes Back? Measuring Long-Run Risk," Journal of Political Economy, University of Chicago Press, vol. 116(2), pages 260-302, April.
    13. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," Sciences Po publications info:hdl:2441/8686, Sciences Po.
    14. George M. Constantinides & Anisha Ghosh, 2011. "Asset Pricing Tests with Long-run Risks in Consumption Growth," Review of Asset Pricing Studies, Oxford University Press, vol. 1(1), pages 96-136.
    15. Lars Peter Hansen, 2007. "Beliefs, Doubts and Learning: Valuing Economic Risk," NBER Working Papers 12948, National Bureau of Economic Research, Inc.
    16. Costis Skiadas, 1998. "Recursive utility and preferences for information," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 12(2), pages 293-312.
    17. Jesper Rangvid & Maik Schmeling & Andreas Schrimpf, 2009. "Global Asset Pricing: Is There a Role for Long-run Consumption Risk?," CREATES Research Papers 2009-57, Department of Economics and Business Economics, Aarhus University.
    18. Hasseltoft, Henrik, 2012. "Stocks, Bonds, and Long-Run Consumption Risks," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(2), pages 309-332, April.
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    More about this item

    Keywords

    recursive preferences; Epstein-Zin preferences; uncertainty aversion; information processing; time inconsistency;

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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