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Asset Returns and State-Dependent Risk Preferences

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  • Stephen Gordon
  • Pascal St-Amour

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 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 asests.
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Suggested Citation

  • Stephen Gordon & Pascal St-Amour, 2003. "Asset Returns and State-Dependent Risk Preferences," CIRANO Working Papers 2003s-09, CIRANO.
    • Handle: RePEc:cir:cirwor:2003s-09
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    File URL: https://cirano.qc.ca/files/publications/2003s-09.pdf
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    Keywords

    Asset Pricing Models; Bayesian Analysis; Continuous-time Econometric Models; Data Augmentation; Equity Premium Puzzle; Markov Chain Monte Carlo; Risk Aversion; State-Dependent Preferences; Wealth; Modèles de prix des actifs; analyse bayesienne; modèles économétriques en temps continu; augmentation de données; énigme de la prime de risque; chaîne markovienne de Monte Carlo; aversion au risque; préférences contingentes; richesse;
    All these keywords.

    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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