Endogenous time-varying risk aversion and asset return

Michele Berardi

Centre for Growth and Business Cycle Research Discussion Paper Series from Economics, The University of Manchester

Abstract: Stylized facts about statistical properties for short horizon returns in financial markets have been identified in the literature, but a common cause for their manifestation has yet to be found. We show that a simple asset pricing model with representative agent and rational expectations is able to generate time series of returns that replicate such stylized facts if the risk aversion coefficient is allowed to change endogenously over time in response to unexpected excess returns. The same model, under constant risk aversion, would instead generate returns that are essentially Gaussian. We conclude that an endogenous time-varying risk aversion represents a very parsimonious way to make the model match real data on key statistical properties, and therefore deserves careful consideration from economists and practitioners alike.

Pages: 22 pages
Date: 2012
New Economics Papers: this item is included in nep-upt
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Journal Article: Endogenous time-varying risk aversion and asset returns (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:man:cgbcrp:168

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