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Measuring State-Dependent Risk Aversion Using Data Augmentation


  • GORDON, Stephen


  • ST-AMOUR, Pascal


We propose a continuous-time consumption-based capital asset pricing model in which the representative agent's preferences display state-dependent risk aversion. Since fluctuations in marginal utility can be ascribed to variations in levels of risk aversion as well as in levels of consumption, we obtain a valuation equation in which the vector of excess returns on equity reflects both consumption risk as well as the risk associated with variations in the state variables. We develop a simple model that can be estimated without specifying the functional form linking risk aversion with wealth and state variables. Our estimates are based on a Bayesian analysis of exact discrete-time parametrisations for continuous-time 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 centered at 0.9 and are highly counter-cyclical, i.e. decreasing in unanticipated shocks to consumption.

Suggested Citation

  • GORDON, Stephen & ST-AMOUR, Pascal, 1995. "Measuring State-Dependent Risk Aversion Using Data Augmentation," Cahiers de recherche 9507, Université Laval - Département d'économique.
  • Handle: RePEc:lvl:laeccr:9507

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    1. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
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    6. Richard Black & David Rose, 1997. "Canadian Policy Analysis Model: CPAM," Staff Working Papers 97-16, Bank of Canada.
    7. Reinhart, Carmen & Ostry, Jonathan, 1991. "Private Saving and Terms of Trade Shocks," MPRA Paper 13716, University Library of Munich, Germany.
    8. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-247, April.
    9. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-417, June.
    10. Abdelhak S Senhadji, 1997. "Sources of Debt Accumulation in a Small Open Economy," IMF Working Papers 97/146, International Monetary Fund.
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