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A consumption-based asset pricing model with disappointment aversion and uncertainty shocks

Kaifeng Li, Bobo Xia and Zhaoxuan Guo

Economic Modelling, 2021, vol. 94, issue C, 235-243

Abstract: We study a consumption-based asset pricing model with ‘good’ and ‘bad’ uncertainties. Good and bad uncertainties are characterized by two gamma distributions with time-varying shape parameters and they respectively represent potentially fat-tailed, skewed positive and negative innovations to consumption growth. The representative agent has generalized disappointment aversion preferences. We show that disappointment aversion is important for generating a low risk-free rate and high equity premium, and additionally, while the influence of the elasticity of intertemporal substitution (EIS) on equity premium is negligible, the EIS is important for delivering reasonable implications on the market prices of the two uncertainty components.

Keywords: Asset pricing; Consumption growth; Disappointment aversion; Equity premium; Uncertainty (search for similar items in EconPapers)
JEL-codes: C61 D81 G11 G12 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.econmod.2020.09.016

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