Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices

Marco Bonomo, René Garcia, Nour Meddahi and Roméo Tédongap

No 636, IDEI Working Papers from Institut d'Économie Industrielle (IDEI), Toulouse

Abstract: We propose an asset pricing model where preferences display generalized disappointment aversion (Routledge and Zin, 2009) and the endowment process involves long-run volatility risk. These preferences, which are embedded in the Epstein and Zin (1989) recursive utility framework, overweight disappointing results as compared to expected utility, and display relatively larger risk aversion for small gambles. With a Markov switching model for the endowment process, we derive closed-form solutions for all returns moments and predictability regressions. The model produces first and second moments of price-dividend ratios and asset returns and return predictability patterns in line with the data. Compared to Bansal and Yaron (2004), we generate: i) more predictability of excess returns by price-dividend ratios; ii) less predictability of consumption growth rates by price-dividend ratios. Differently from the Bansal and Yaron model, our results do not depend on a value of the elasticity of intertemporal substitution greater than one.

JEL-codes: C1 C5 G1 G11 G12 (search for similar items in EconPapers)
Date: 2010-06
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (4)

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Related works:
Journal Article: Generalized Disappointment Aversion, Long-run Volatility Risk, and Asset Prices (2011)
Working Paper: Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:ide:wpaper:23192

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