Generalized Disappointment Aversion and Asset Prices
40 Pages Posted: 21 Nov 2003 Last revised: 13 Feb 2022
Date Written: November 2003
Abstract
We provide an axiomatic model of preferences over atemporal risks that generalizes Gul (1991) A Theory of Disappointment Aversion' by allowing risk aversion to be first order' at locations in the state space that do not correspond to certainty. Since the lotteries being valued by an agent in an asset-pricing context are not typically local to certainty, our generalization, when embedded in a dynamic recursive utility model, has important quantitative implications for financial markets. We show that the state-price process, or asset-pricing kernel, in a Lucas-tree economy in which the representative agent has generalized disappointment aversion preferences is consistent with the pricing kernel that resolves the equity-premium puzzle. We also demonstrate that a small amount of conditional heteroskedasticity in the endowment-growth process is necessary to generate these favorable results. In addition, we show that risk aversion in our model can be both state-dependent and counter-cyclical, which empirical research has demonstrated is necessary for explaining observed asset-pricing behavior.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior
By John Y. Campbell and John H. Cochrane
-
By Force of Habit: A Consumption-Based Explanation of Plantation of Aggregate Stock Market Behavior
By John Y. Campbell and John H. Cochrane
-
Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing
By John Heaton and Deborah J. Lucas
-
Asset Prices Under Habit Formation and Catching Up with the Joneses
-
Implications of Security Market Data for Models of Dynamic Economies
-
Myopic Loss Aversion and the Equity Premium Puzzle
By Shlomo Benartzi and Richard H. Thaler