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Risk Aversion, the Labor Margin, and Asset Pricing in DSGE Models

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  • Eric Swanson

    (Federal Reserve Bank of San Francisco)

Abstract

In dynamic equilibrium models, the household's labor margin has dramatic effects on risk aversion, and hence asset prices, even when utility is additively separable between consumption and labor. This paper derives simple, closed-form expressions for risk aversion that take into account the household's labor margin. Ignoring the labor margin can wildly overstate the household's true aversion to risk. Risk premia on assets priced with the stochastic discount factor increase essentially linearly with risk aversion, so measuring risk aversion correctly is crucial for asset pricing in the model. Closed-form expressions for risk aversion in DSGE models with generalized recursive preferences and internal and external habits are also derived.

Suggested Citation

  • Eric Swanson, 2010. "Risk Aversion, the Labor Margin, and Asset Pricing in DSGE Models," 2010 Meeting Papers 138, Society for Economic Dynamics.
  • Handle: RePEc:red:sed010:138
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    1. Benveniste, L M & Scheinkman, J A, 1979. "On the Differentiability of the Value Function in Dynamic Models of Economics," Econometrica, Econometric Society, vol. 47(3), pages 727-732, May.
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    7. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-543, June.
    8. TallariniJr., Thomas D., 2000. "Risk-sensitive real business cycles," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 507-532, June.
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    11. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-969, July.
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    Cited by:

    1. Ferman, Marcelo, 2011. "Switching Monetary Policy Regimes and the Nominal Term Structure," Dynare Working Papers 5, CEPREMAP.
    2. van Binsbergen, Jules H. & Fernández-Villaverde, Jesús & Koijen, Ralph S.J. & Rubio-Ramírez, Juan, 2012. "The term structure of interest rates in a DSGE model with recursive preferences," Journal of Monetary Economics, Elsevier, vol. 59(7), pages 634-648.
    3. Gourio, François & Siemer, Michael & Verdelhan, Adrien, 2013. "International risk cycles," Journal of International Economics, Elsevier, vol. 89(2), pages 471-484.
    4. Hakon Tretvoll, 2012. "Real exchange rate variability in a two country business cycle model," 2012 Meeting Papers 911, Society for Economic Dynamics.
    5. Gourio, François, 2012. "Macroeconomic implications of time-varying risk premia," Working Paper Series 1463, European Central Bank.

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