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Substitution, Risk Aversion, Taste Shocks and Equity Premia

  • Michel Normandin

    (CREFE/UQAM)

  • Pascal St-Amour

    (Univeriste Laval)

This paper investigates the testable restrictions on the time-series behavior of equity premia implied by a representative agent model whose state- and time-non separable preferences are subject to taste shocks. The model nests state- and time-separable preferences with and without taste shocks as special cases. Empirically, the linearized Euler equations are estimated through Kalman filtering, allowing for conditional heteroscedasticity via a common factor GARCH process. With or without conditional heteroscedasticity, (i) the hypothesis that preferences are separable cannot be rejected, (ii) taste shocks influences are statistically significant, and (iii) taste shocks yield reasonable estimates of the coefficient of relative risk aversion. This last result occurs because taste shocks reproduce the large observed equity premium by shifting weight away from consumption risk in favor to taste risk. This paper is available at ftp://crefe.dse.uqam.ca/pub/cahiers/cah39.ps The whole WP list is at http://www.er.uqam.ca/nobel/crefe/cahiers.html

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Paper provided by EconWPA in its series Finance with number 9607001.

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Length: 29 pages
Date of creation: 03 Jul 1996
Date of revision:
Handle: RePEc:wpa:wuwpfi:9607001
Note: 29 pages, Postscript file
Contact details of provider: Web page: http://econwpa.repec.org

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