Time-Varying Risk Aversion and Unexpected Inflation
42 Pages Posted: 8 Feb 2009 Last revised: 10 Feb 2009
Abstract
We formulate a consumption-based asset pricing model in which aggregate risk aversion is time-varying in response to both news about consumption growth (as in a habit formation model) and news about inflation. We estimate our model and explore its pricing implications on the term structure of interest rates and the cross-section of stock returns. Our empirical results support the hypothesis that aggregate risk aversion varies in response to news about inflation. The induced time-variation in risk aversion does not appear to proxy for inflation uncertainty or economic growth.
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