Revisiting Equity Premium Puzzles in a Data-Rich Environment

2019 ◽  
Vol 65 (4) ◽  
pp. 257-275
Author(s):  
Mohamed Douch ◽  
Mohammed Bouaddi
Keyword(s):  
Relative Risk ◽  
Risk Aversion ◽  
Equity Premium ◽  
Time Varying ◽  
Relative Risk Aversion ◽  
Marginal Rate ◽  
Marginal Rate Of Substitution ◽  
Premium Puzzle ◽  
The Interest Rate ◽  
Risk Free Rate

Abstract This paper modifies the conventional representative-agent consumption-based equilibrium models by making the habit-formation part depend on additional factors related to economic conditions. This paper assumes that innovations in the consumption surplus ratio are determined not only by consumption growth but also by other macroeconomic and financial factors. The resulting model allowed for a separation between the intertemporal elasticity of substitution and risk aversion. The model also generates highly volatile Intertemporal marginal rate of substitution which translates into fluctuating volatility capturing time varying economic uncertainty. The long-standing equity premium puzzle seems to have been resolved. The resulting pricing model accounts for a number of interesting properties, such as time-varying risk aversion, small relative risk aversion and an equity premium that is compatible with the observed equity premium. These results are obtained with admissible range of local relative risk aversion. In addition, the model generated small risk-free rate resolving the interest rate puzzle.

scholarly journals Solution to the Equity Premium Puzzle

2021 ◽  
Author(s):  
Atilla Aras
Keyword(s):  
Relative Risk ◽  
Risk Aversion ◽  
Risk Behavior ◽  
Empirical Studies ◽  
Equity Premium ◽  
Subjective Time ◽  
Relative Risk Aversion ◽  
Equity Premium Puzzle ◽  
Time Discount ◽  
Premium Puzzle

This study provides a solution of the equity premium puzzle. Questioning the validity of the Arrow-Pratt measure of relative risk aversion for detecting the risk behavior of investors, a new tool in the form of the sufficiency factor of the model was developed to analyze the risk behavior of investors. The calculations of this newly tested model show that the value of the coefficient of relative risk aversion is 1.033526 by assuming the value of the subjective time discount factor as 0.99. Since these values are compatible with the existing empirical studies, they confirm the validity of the newly derived model that provides a solution to the equity premium puzzle.

scholarly journals Impact of the degree of relative risk aversion, the interest rate and the exchange rate depreciation on economic welfare in a small open economy

2018 ◽  
Vol 13 (25) ◽  
pp. 18
Author(s):  
Yazmín Viridiana Soriano-Morales ◽  
Benjamín Vallejo-Jiménez ◽  
Francisco Venegas-Martínez
Keyword(s):  
Exchange Rate ◽  
Relative Risk ◽  
Interest Rate ◽  
Risk Aversion ◽  
Economic Welfare ◽  
Relative Risk Aversion ◽  
The Interest Rate ◽  
Different Levels ◽  
Nominal Variables ◽  
Exchange Rate Depreciation

This paper is aimed at assessing the impact of the degree of relative risk aversion on economic welfare for different levels of the interest rate and the exchange rate depreciation in a small open beconomy. To do this, a representative consumer-producer makes decisions on consumption, money balances, and leisure. In order to find a closed-form solution of the household’s economic welfare, it is assumed that individual’s preferences belong to the family of Constant Relative Risk Aversion (CRRA) utility functions. Several comparative statics graphical experiments about the effects of the degree of relative risk aversion on economic welfare for different levels of nominal variables are carried out. Finally, we find that, under the stated assumptions, household’s economic welfare seen as a function of the degree of relative risk aversion is responsive to different values of nominal variables.

Time-Varying Risk Aversion and Dynamic Portfolio Allocation

2021 ◽  
Author(s):  
Haitao Li ◽  
Chongfeng Wu ◽  
Chunyang Zhou
Keyword(s):  
Relative Risk ◽  
Risk Aversion ◽  
Regime Switching ◽  
Dynamic Programming Algorithm ◽  
Portfolio Allocation ◽  
Programming Algorithm ◽  
Time Varying ◽  
Relative Risk Aversion ◽  
Bear Market ◽  
Dynamic Portfolio

Despite the overwhelming evidence of time-varying risk aversion documented in recent literature, standard dynamic portfolio theories often adopt an assumption of constant (relative) risk aversion due to analytical tractability. In “Time Varying Risk Aversion and Dynamic Portfolio Allocation,” Li et al. explicitly consider the implications of time-varying risk aversion for dynamic portfolio allocation under the framework of regime-switching models. An investor with regime-dependent utility exhibits a decreasing relative risk aversion (DRRA) and has higher risk aversion when a bear market regime is more likely in the future. They develop an efficient dynamic programming algorithm that overcomes the challenges imposed by regime-dependent preference in obtaining time-consistent portfolio policies. The empirical results show that VIX is an important predictor of regime shifts and that investors with regime-dependent risk aversion achieve better investment performance than those with constant risk aversion.

Relative Risk Aversion and Portfolio Choice

2005 ◽  
Author(s):  
Pablo Muñoz Ceballos ◽  
Esteban Flores Díaz
Keyword(s):  
Relative Risk ◽  
Risk Aversion ◽  
Portfolio Choice ◽  
Relative Risk Aversion

scholarly journals Relative risk aversion models: How plausible are their assumptions?

2021 ◽  
pp. 104346312199408
Author(s):  
Carlo Barone ◽  
Katherin Barg ◽  
Mathieu Ichou
Keyword(s):  
Relative Risk ◽  
Risk Aversion ◽  
Loss Aversion ◽  
Educational Inequality ◽  
Risky Choice ◽  
Relative Risk Aversion ◽  
Downward Mobility ◽  
Educational Decisions ◽  
Empirically Supported ◽  
Occupational Risks

This work examines the validity of the two main assumptions of relative risk-aversion models of educational inequality. We compare the Breen-Goldthorpe (BG) and the Breen-Yaish (BY) models in terms of their assumptions about status maintenance motives and beliefs about the occupational risks associated with educational decisions. Concerning the first assumption, our contribution is threefold. First, we criticise the assumption of the BG model that families aim only at avoiding downward mobility and are insensitive to the prospects of upward mobility. We argue that the loss-aversion assumption proposed by BY is a more realistic formulation of status-maintenance motives. Second, we propose and implement a novel empirical approach to assess the validity of the loss-aversion assumption. Third, we present empirical results based on a sample of families of lower secondary school leavers indicating that families are sensitive to the prospects of both upward and downward mobility, and that the loss-aversion hypothesis of BY is empirically supported. As regards the risky choice assumption, we argue that families may not believe that more ambitious educational options entail occupational risks relative to less ambitious ones. We present empirical evidence indicating that, in France, the academic path is not perceived as a risky option. We conclude that, if the restrictive assumptions of the BG model are removed, relative-risk aversion needs not drive educational inequalities.

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