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Endogenous time-varying risk aversion and asset return

  • Michele Berardi

Stylized facts about statistical properties for short horizon returns in financial markets have been identified in the literature, but a common cause for their manifestation has yet to be found. We show that a simple asset pricing model with representative agent and rational expectations is able to generate time series of returns that replicate such stylized facts if the risk aversion coefficient is allowed to change endogenously over time in response to unexpected excess returns. The same model, under constant risk aversion, would instead generate returns that are essentially Gaussian. We conclude that an endogenous time-varying risk aversion represents a very parsimonious way to make the model match real data on key statistical properties, and therefore deserves careful consideration from economists and practitioners alike.

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File URL: http://hummedia.manchester.ac.uk/schools/soss/cgbcr/discussionpapers/dpcgbcr168.pdf
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Paper provided by Economics, The Univeristy of Manchester in its series Centre for Growth and Business Cycle Research Discussion Paper Series with number 168.

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Length: 22 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:man:cgbcrp:168
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