Risk Aversion and the Labor Margin in Dynamic Equilibrium Models

2012 ◽  
Vol 102 (4) ◽  
pp. 1663-1691 ◽  
Author(s):  
Eric T Swanson
Keyword(s):  
Asset Pricing ◽  
Risk Aversion ◽  
Closed Form ◽  
Asset Prices ◽  
Dynamic Equilibrium ◽  
Risk Premia ◽  
Substantial Effect ◽  
Discount Factor ◽  
Stochastic Discount Factor ◽  
Equilibrium Models

The household's labor margin has a substantial effect on risk aversion, and hence asset prices, in dynamic equilibrium models 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 this margin can dramatically 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.

THE SHARPE RATIO AND PREFERENCES: A PARAMETRIC APPROACH

2002 ◽  
Vol 6 (2) ◽  
pp. 242-265 ◽  
Author(s):  
Martin Lettau ◽  
Harald Uhlig
Keyword(s):  
Asset Pricing ◽  
Habit Formation ◽  
Market Price ◽  
Sharpe Ratio ◽  
Discount Factor ◽  
Stochastic Discount Factor ◽  
Parametric Approach ◽  
Recursive Preferences ◽  
Convenient Tool ◽  
Log Normal

We use a log-normal framework to examine the effect of preferences on the market price for risk, that is, the Sharpe ratio. In our framework, the Sharpe ratio can be calculated directly from the elasticity of the stochastic discount factor with respect to consumption innovations as well as the volatility of consumption innovations. This can be understood as an analytical shortcut to the calculation of the Hansen–Jagannathan volatility bounds, and therefore provides a convenient tool for theorists searching for models capable of explaining asset-pricing facts. To illustrate the usefulness of our approach, we examine several popular preference specifications, such as CRRA, various types of habit formation, and the recursive preferences of Epstein–Zin–Weil. Furthermore, we show how the models with idiosyncratic consumption shocks can be studied.

Intermediary Asset Pricing and the Financial Crisis

2018 ◽  
Vol 10 (1) ◽  
pp. 173-197 ◽  
Author(s):  
Zhiguo He ◽  
Arvind Krishnamurthy
Keyword(s):  
Asset Pricing ◽  
Financial Crisis ◽  
Empirical Evidence ◽  
Asset Prices ◽  
Financial Intermediation ◽  
Risk Premia

Intermediary asset pricing understands asset prices and risk premia through the lens of frictions in financial intermediation. Perhaps motivated by phenomena in the financial crisis, intermediary asset pricing has been one of the fastest-growing areas of research in finance. This article explains the theory behind intermediary asset pricing and, in particular, how it is different from other approaches to asset pricing. This article also covers selective empirical evidence in favor of intermediary asset pricing.

scholarly journals Dynamic General Equilibrium and T-Period Fund Separation

2010 ◽  
Vol 45 (2) ◽  
pp. 369-400 ◽  
Author(s):  
Anke Gerber ◽  
Thorsten Hens ◽  
Peter Woehrmann
Keyword(s):  
Asset Pricing ◽  
Risk Aversion ◽  
General Equilibrium ◽  
Asset Allocation ◽  
Mutual Fund ◽  
Asset Prices ◽  
Dynamic General Equilibrium ◽  
Discount Factors ◽  
Equilibrium Asset Pricing ◽  
Mutual Fund Separation

AbstractIn a dynamic general equilibrium model, we derive conditions for a mutual fund separation property by which the savings decision is separated from the asset allocation decision. With logarithmic utility functions, this separation holds for any heterogeneity in discount factors, while the generalization to constant relative risk aversion holds only for homogeneous discount factors but allows for any heterogeneity in endowments. The logarithmic case provides a general equilibrium foundation for the growth-optimal portfolio literature. Both cases yield equilibrium asset pricing formulas that allow for investor heterogeneity, in which the return process is endogenous and asset prices are determined by expected discounted relative dividends. Our results have simple asset pricing implications for the time series as well as the cross section of relative asset prices. It is found that on data from the Dow Jones Industrial Average, a risk aversion smaller than in the logarithmic case fits best.

Asset Pricing III: Arbitrage-Based Pricing

2019 ◽  
pp. 72-84
Author(s):  
Harold L. Cole
Keyword(s):  
Asset Pricing ◽  
Discount Factor ◽  
Stochastic Discount Factor ◽  
Pricing Model

This chapter develops a arbitrage-based pricing model in which the extent to which the stochastic discount factor varies is unrestricted.

scholarly journals Disasterization: A Simple Way to Fix the Asset Pricing Properties of Macroeconomic Models

2011 ◽  
Vol 101 (3) ◽  
pp. 406-409 ◽  
Author(s):  
Xavier Gabaix
Keyword(s):  
Asset Pricing ◽  
Business Cycle ◽  
Capital Stock ◽  
Asset Prices ◽  
Risk Premia ◽  
Macroeconomic Models ◽  
Macro Variables

A central difficulty in economics is to create a model with both good business cycle properties and asset pricing properties. I show how to solve this difficulty by a simple portable modeling device: the “disasterization” of models. Take an economy with good business cycle properties and create a new, “disasterized” economy, which is essentially identical to the original one except that disasters can destroy part of the capital stock and productivity. In such a disasterized economy, asset prices exhibit high and volatile risk premia, but macro variables remain unchanged. Perturbations of this benchmark allow for feedback from finance to macro.

New Entropy Restrictions and the Quest for Better-Specified Asset-Pricing Models

2018 ◽  
Vol 54 (6) ◽  
pp. 2517-2541 ◽  
Author(s):  
Gurdip Bakshi ◽  
Fousseni Chabi-Yo
Keyword(s):  
Asset Pricing ◽  
Lower Bound ◽  
Finite Number ◽  
Upper Bound ◽  
Discount Factor ◽  
Stochastic Discount Factor ◽  
Pricing Models ◽  
Asset Pricing Models

This article proposes the entropy of m2 (m is the stochastic discount factor) as a metric to evaluate asset-pricing models. We develop a bound on the entropy of m2 when m correctly prices a finite number of returns and consider models that pass the lower bound on m, yet fail the lower bound on m2. Interpreting our results, we elaborate on the distinction between the entropy of m2 versus the entropy of m. We further show that the entropy of m2 represents an upper bound on the expected excess (log) return of the security with the payoff of m.

The Functional Stochastic Discount Factor

2019 ◽  
Vol 09 (04) ◽  
pp. 1950013 ◽  
Author(s):  
Ngoc-Khanh Tran
Keyword(s):  
Asset Pricing ◽  
Interest Rate ◽  
Term Structure ◽  
Discount Factor ◽  
Stochastic Discount Factor ◽  
State Variables ◽  
Interest Rate Models ◽  
Risk Neutral ◽  
Premium Puzzle ◽  
Linear Differential

By assuming that the stochastic discount factor (SDF) [Formula: see text] is a proper but unspecified function of state variables [Formula: see text], we show that this function [Formula: see text] must solve a simple second-order linear differential equation specified by state variables’ risk-neutral dynamics. Therefore, this assumption determines the most general possible SDFs and associated preferences, that are consistent with the given risk-neutral state dynamics and interest rate. A consistent SDF then implies the corresponding state dynamics in the data-generating measure. Our approach offers novel flexibilities to extend several popular asset pricing frameworks: affine and quadratic interest rate models, as well as models built on linearity-generating processes. We illustrate the approach with an international asset pricing model in which (i) interest rate has an affine dynamic term structure and (ii) the forward premium puzzle is consistent with consumption-risk rationales; the two asset pricing features previously deemed conceptually incompatible.

Sign in / Sign up

Export Citation Format

Share Document