State-Dependent Risk Aversion
The traditional representative agent, consumption-based asset pricing model with iso-elastic utility has not performed well empirically. Alternative specifications have focused on the rigidities implied by the Von Neuman-Morgenstern axioms of choice under uncertainty, in particular the independence hypothesis, and proposed some degree of generalization. This has been achieved while retaining constant risk aversion for the within-period utility function. The purpose of this paper is to present further flexibility through the risk aversion specification, within the context of non-expected utility, through relaxation of the iso-elasticity assumption. By allowing attitudes toward risk to reflect the information set used for the decision process, risk aversion is no longer fixed, but responds to the evolution in the state of the world as well as the distributional assumptions governing the state variables. The advantage is that the same individual may be a risk-lover over certain states and distributions, while being risk averse over others. The model is developed within a continuous-time setting for consumption and leverage choices. The closed form solution for the risk aversion function gives results that are appealing on intuitive grounds. In particular, risk aversion increases in the variance of the risky return, and falls in wealth and equity premium. Estimation results are presented.
|Date of creation:||Jan 1994|
|Contact details of provider:|| Postal: Kingston, Ontario, K7L 3N6|
Phone: (613) 533-2250
Fax: (613) 533-6668
Web page: http://qed.econ.queensu.ca/
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:qed:wpaper:896. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mark Babcock)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.