Risk aversion, the labor margin, and asset pricing in DSGE models

Eric Swanson

No 2009-26, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: In dynamic stochastic general equilibrium (DSGE) models, the household's labor margin as well as consumption margin affects Arrow-Pratt risk aversion. This paper derives simple, closed-form expressions for risk aversion that take into account the household's labor margin. Ignoring the labor margin can lead to wildly inaccurate measures of the household's true attitudes toward risk. We show that risk premia on assets computed using the stochastic discount factor are proportional to Arrow-Pratt risk aversion, so that measuring risk aversion correctly is crucial for understanding asset prices. Closed-form expressions for risk aversion in DSGE models with generalized recursive preferences and internal and external habits are also derived.

Keywords: Financial risk management; Asset pricing (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-bec, nep-dge and nep-upt
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Citations: View citations in EconPapers (6)

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Related works:
Working Paper: Risk Aversion, the Labor Margin, and Asset Pricing in DSGE Models (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedfwp:2009-26

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