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Substitution, Risk Aversion, Taste Shocks and Equity Premia

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Abstract

This paper investigates the testable restrictions on the time-series behavior of equity premia implied by a representative agent model whose state- and time-non separable preferences are subject to taste shocks. The model nests state- and time-separable preferences with and without taste shocks as special cases. Empirically, the linearized Euler equations are estimated through Kalman filtering, allowing for conditional heteroscedasticity via a common factor GARCH process. With or without conditional heteroscedasticity, (i) the hypothesis that preferences are separable cannot be rejected, (ii) taste shocks influences are statistically significant, and (iii) taste shocks yield reasonable estimates of the coefficient of relative risk aversion. This last result occurs because taste shocks reproduce the large observed equity premium by shifting weight away from consumption risk in favor to taste risk. Cette étude vise à expliquer les primes associées aux titres financiers risqués (soit la différence entre les rendements que procurent les titres et les taux d'intérêt). Les restrictions testés sont dérivées à partir d'un modèle d'agent représentatif dont la fonction d'utilité est non séparable (par rapport au temps et aux états) et inclut des chocs de préférences. La méthodologie empirique consite à estimer les équations d'Euler linéarisées au moyen de filtres de Kalman et de processus GARCH. Les résultats indiquent d'abord que l'hypothèse de séparabilité n'est pas rejetée. Aussi, les chocs de préférence affectent significativement les primes et engendrent des estimés réalistes des coefficients d'aversion relative au risque. Ce dernier résultat implique que le risque de consommation est faible. Néanmoins, la présence de chocs de préférence permet de reproduire les fortes primes observées. Finalement, ces résultats ne sont pas altérés suite à l'inclusion d'hétéroscédasticité conditionnelle.

Suggested Citation

  • Michel Normandin & Pascal St-Amour, 1996. "Substitution, Risk Aversion, Taste Shocks and Equity Premia," Cahiers de recherche CREFE / CREFE Working Papers 39, CREFE, Université du Québec à Montréal.
  • Handle: RePEc:cre:crefwp:39
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    Keywords

    conditional heteroskedasticity; consumption-based capital asset pricing model; Kalman filter; latent variables; state- and time-non-separable preferences; state- and time-separable preferences;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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