Risk Aversion and Changes in Regime

Tomas E. Caravello, John Driffill, Turalay Kenc and Martin Sola
Additional contact information
Tomas E. Caravello: Massachusetts Institute of Technology
John Driffill: Yale-NUS
Turalay Kenc: University of Cambridge

No 237, Working Papers from Red Nacional de Investigadores en Economía (RedNIE)

Abstract: We develop and estimate a consumption-based asset pricing model that assumes recursive utility using historical US financial data, allowing for regime changes, priced regime risk, and intrinsic bubbles. We also estimate several restricted versions which include only a subset of these features. We find that switching risk is an essential component of the equity risk premium, explaining up to fifty percent of it. Furthermore, a model which does not take this into account would overestimate the degree of risk aversion of the public, mistakenly assigning the observed risk premium to high-risk aversion instead of priced regime-switching. Intrinsic bubbles are not crucial in explaining the risk premia, but they substantially improve the model’s fit at the end of the sample.

Keywords: Equity Risk Premium; Macroeconomic Risk; Stochastic Differential Utility; Markov Chain; Intrinsic Bubbles (search for similar items in EconPapers)
JEL-codes: C32 E44 G00 G12 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2023-04
New Economics Papers: this item is included in nep-rmg and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://rednie.eco.unc.edu.ar/files/DT/237.pdf (application/pdf)

Related works:
Working Paper: Risk Aversion and Changes in Regime (2021)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:aoz:wpaper:237

Access Statistics for this paper

More papers in Working Papers from Red Nacional de Investigadores en Economía (RedNIE) Contact information at EDIRC.
Bibliographic data for series maintained by Laura Inés D Amato ().