Belief Dependent Utilities, Aversion to State-Uncertainty and Asset Prices

Pietro Veronesi

No 2965, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This Paper reinterprets standard axioms in choice theory to introduce the concepts of ?belief dependent? utility functions and aversion to ?state-uncertainty?. It shows that this type of preference helps to explain the various stylized facts of asset returns, including a high equity risk premium, a low risk-free rate, a high return volatility, stock return predictability and volatility clustering. In one particular specification consistent with habit formation preferences, I also argue that ?aversion to state-uncertainty? gives rise to ?aversion to long-run risk?, that is, to the uncertainty surrounding the long-run average of future consumption. In order to solve for asset prices and returns under general conditions about the hidden state variable, the Paper also develops a discretization methodology to obtain approximate analytical solutions. In a parsimonious parametrization, I then show that the model calibrated to real consumption generates unconditional moments for asset returns that closely match the empirical ones. Finally, due to the estimated time-variation in the dispersion of the conditional distribution on the drift rate of consumption, the model also generates a time series of conditional return volatility in line with the ex-post integrated volatility of stock returns.

Keywords: State dependent prefereneces; Uncertainty aversion; Asset pricing (search for similar items in EconPapers)
JEL-codes: D81 G12 (search for similar items in EconPapers)
Date: 2001-09
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://cepr.org/publications/DP2965 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
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:cpr:ceprdp:2965

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP2965

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().