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Asset Prices with Contingent Preferences


  • Gordon, Stephen


  • St-Amour, Pascal


This paper develops a consumption-based asset pricing model in which attitudes towards risk are contingent upon the state of the world. For low (high) level of consumption relative to a subjective metric, counter-cyclical (pro-cyclical) risk aversion implies that consumption shocks generate larger fluctuations in marginal utility, against which the agent will hedge in choosing his optimal portfolio. Asset prices are studied using two-state Markov preference regimes where bull and bear markets reflect alternating periods of low and high risk aversion. Joint estimation of bond and stock prices highlights moderate and infrequent movements in risk aversion, and a marked improvement on the model's ability to capture the cyclical nature of observed asset prices. We also study implications for returns under Itô preference states, and show why contingent risk preferences have the potential to resolve the empirical anomalies for asset returns. Exact likelihood estimation of joint diffusion processes using market excess returns data also point toward realistic and counter-cyclical estimates of risk aversion. Ce papier développe un modèle d'agent représentatif de valorisation des actifs dans lequel les préférences sont contingentes à l'état du monde. Lorsque la consommation est basse (élevée) par rapport à un niveau subjectif, une aversion contra- (pro-) cyclique implique que des chocs à la consommation se traduisent par des fluctuations accentuées de l'utilité marginale que l'agent désirera lisser lors de son choix du protefeuille optimal. Les prix des actifs sont étudiés dans le cadre d'un modèle markovien à deux états où les marchés haussiers ou baissiers reflètent des périodes alternatives de basse et de haute aversion pour le risque. L'estimation conjointe des prix des bons et des actions mettent en évidence des mouvements modérés et peu fréquents dans l'aversion au risque ainsi qu'une amélioration nette du modèle en ce qui a trait aux mouvements cycliques des prix. Nous étudions également les implications pour les rendements à l'aide d'états de préférence Itô et démontront pourquoi le modèle a le potentiel nécessaire pour résoudre les anomalies empiriques des rendements. L'estimation des processus conjoints de diffusion est basée sur les vraisemblances exactes et suggère la présence d'aversion au risque raisonnable et contra-cyclique.

Suggested Citation

  • Gordon, Stephen & St-Amour, Pascal, 1997. "Asset Prices with Contingent Preferences," Cahiers de recherche 9712, Université Laval - Département d'économique, revised 08 Jun 1998.
  • Handle: RePEc:lvl:laeccr:9712

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    References listed on IDEAS

    1. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    2. Robson, Arthur J, 1992. "Status, the Distribution of Wealth, Private and Social Attitudes to Risk," Econometrica, Econometric Society, vol. 60(4), pages 837-857, July.
    3. Dale J. Poirier, 1995. "Intermediate Statistics and Econometrics: A Comparative Approach," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161494, January.
    4. Karni, Edi, 1983. "Risk Aversion for State-Dependent Utility Functions: Measurement and Applications," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 24(3), pages 637-647, October.
    5. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    6. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    7. John Y. Campbell, 1996. "Consumption and the Stock Market: Interpreting International Experience," NBER Working Papers 5610, National Bureau of Economic Research, Inc.
    8. Narayana R. Kocherlakota, 1996. "The Equity Premium: It's Still a Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(1), pages 42-71, March.
    9. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, vol. 49(3), pages 555-574, May.
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    Cited by:

    1. Don Harding & Adrian Pagan, 1999. "Knowing the Cycle," Melbourne Institute Working Paper Series wp1999n12, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
    2. Kirill Sossunov, 2002. "A Real Business Cycle Model with Changing Sentiments," Macroeconomics 0210005, EconWPA.

    More about this item


    Asset pricing models; Bayesian analysis; excess volatility; exact likelihood estimation of diffusion processes; Markov chain; regime switching; risk aversion; state-dependent preferences;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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