On the Consequences of State Dependent Preferences for the Pricing of Financial Assets

Jean-Pierre Danthine (), John B. Donaldson, Christos . Giannikos () and Hany Guirguis
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John B. Donaldson: Columbia University
Hany Guirguis: Manhattan College

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: This paper introduces state dependent utility into the standard Mehra and Prescott (1985) economy by allowing the representative agent’s coefficient of relative risk aversion to vary with the underlying economy’s growth rate. Existence of equilibrium is proved and its asymptotic properties analyzed. This generalization leads to level dependent marginal rates of substitution, a property that sharply distinguishes this model from the standard construct. For very low coefficients of relative risk aversion, the equilibrium risk free and risky security returns are demonstrated to have volatilities and an associated equity premium that substantially exceed what is found in the data. This provides a contrasting perspective on the classic “equity premium puzzle.”

Keywords: state dependent utility; equity premium; equity premium puzzle (search for similar items in EconPapers)
JEL-codes: D91 E21 G00 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-fin and nep-mac
Date: 2004-06
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Related works:
Journal Article: On the consequences of state dependent preferences for the pricing of financial assets (2004)
Working Paper: On the Consequences of State Dependent Preferences for the Pricing of Financial Assets (2003)
Working Paper: On the Consequences of State Dependent Preferences for the Pricing of Financial Assets (2002)
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Persistent link: http://EconPapers.repec.org/RePEc:fam:rpseri:rp73

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