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Risk-free Yields, Risk Aversion, and Volatility

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  • Samih Antoine Azar

    (Faculty of Business Administration and Economics, Haigazian University, Mexique Street, Kantari, Beirut, Lebanon.)

Abstract

The classic approach to risk analysis is rooted in the belief that risk aversion is constant, determined by constant preferences. It is becoming clear that this proposition is no longer acceptable. Risk aversion can change over short time, between sovereign countries, and on different financial and capital assets. Secondly volatility of asset prices is itself variable, and can be apprehended like the VIX volatility index which is so popular. Risk-free (RF) yields are affected by this variability in aversion and volatility, contrary to what is commonly envisioned, and contrary to what intuition suggests. This paper assumes complete markets, and simulates 14 values for the volatility, and 25 values for the coefficient of relative risk aversion (CRRA), and it measures the impact of these changes on the RF yield. One conclusion is that the CRRA is indeterminate, and is therefore consistent with the many different estimates in the literature. Another conclusion is that, by setting the volatility to 17.5%, roughly the average stock market volatility over a long period, there is evidence that the range of the implied risk premiums correspond to the range in the empirical literature.

Suggested Citation

  • Samih Antoine Azar, 2017. "Risk-free Yields, Risk Aversion, and Volatility," International Journal of Economics and Financial Issues, Econjournals, vol. 7(3), pages 105-112.
  • Handle: RePEc:eco:journ1:2017-03-15
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Risk Aversion; Volatility; Risk-free Yields; Consumption Strata; Simulation;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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