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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.

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File URL: http://www.ecn.ulaval.ca/w3/recherche/cahiers/1997/9712.pdf
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Paper provided by Université Laval - Département d'économique in its series Cahiers de recherche with number 9712.

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Date of creation: 1997
Date of revision: 08 Jun 1998
Handle: RePEc:lvl:laeccr:9712
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