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Risk aversion, risk premia, and the labor margin with generalized recursive preferences

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  • Eric T. Swanson

Abstract

A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along either or both margins greatly alters the household’s attitudes toward risk, as shown by Swanson (2012). The present paper extends that work to the case of generalized recursive preferences, as in Epstein and Zin (1989) and Weil (1989), which are increasingly being used to bring macroeconomic models into closer agreement with basic asset pricing facts. Measures of risk aversion commonly used in the literature show no stable relationship to the equity premium in a standard RBC model, while the closed-form expressions derived in this paper match the equity premium closely. Thus, measuring risk aversion correctly is crucial for understanding asset prices in the model.

Suggested Citation

  • Eric T. Swanson, 2012. "Risk aversion, risk premia, and the labor margin with generalized recursive preferences," Working Paper Series 2012-17, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2012-17
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    Cited by:

    1. Li, Erica X.N. & Palomino, Francisco, 2014. "Nominal rigidities, asset returns, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 66(C), pages 210-225.
    2. Amisano, Gianni & Tristani, Oreste, 2019. "Uncertainty shocks, monetary policy and long-term interest rates," Working Paper Series 2279, European Central Bank.
    3. Michael Patrick Curran & Scott J. Dressler, 2019. "Preference Heterogeneity, Inflation, and Welfare," Villanova School of Business Department of Economics and Statistics Working Paper Series 40, Villanova School of Business Department of Economics and Statistics.
    4. repec:spr:jbuscr:v:13:y:2017:i:2:d:10.1007_s41549-017-0019-4 is not listed on IDEAS
    5. Martin Kliem & Alexander Meyer-Gohde, 2017. "(Un)expected Monetary Policy Shocks and Term Premia," SFB 649 Discussion Papers SFB649DP2017-015, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    6. Burkhard Heer & Alfred Maußner & Halvor Ruf, 2017. "Q-Targeting in New Keynesian Models," Journal of Business Cycle Research, Springer;Centre for International Research on Economic Tendency Surveys (CIRET), vol. 13(2), pages 189-224, November.
    7. repec:oup:restud:v:85:y:2018:i:1:p:1-49. is not listed on IDEAS
    8. repec:eee:reveco:v:57:y:2018:i:c:p:333-352 is not listed on IDEAS
    9. Martin M Andreasen & Jesús Fernández-Villaverde & Juan F Rubio-Ramírez, 2018. "The Pruned State-Space System for Non-Linear DSGE Models: Theory and Empirical Applications," Review of Economic Studies, Oxford University Press, vol. 85(1), pages 1-49.
    10. Diercks, Anthony M., 2015. "The Equity Premium, Long-Run Risk, & Optimal Monetary Policy," Finance and Economics Discussion Series 2015-87, Board of Governors of the Federal Reserve System (US).
    11. Pecoraro, Brandon, 2017. "Why don't voters ‘put the Gini back in the bottle'? Inequality and economic preferences for redistribution," European Economic Review, Elsevier, vol. 93(C), pages 152-172.
    12. Martin M. Andreasen, 2019. "Explaining Bond Return Predictability in an Estimated New Keynesian Model," CREATES Research Papers 2019-11, Department of Economics and Business Economics, Aarhus University.

    More about this item

    Keywords

    Households - Economic aspects ; Risk assessment;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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