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A consumption-based asset pricing model with disappointment aversion and uncertainty shocks

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  • Li, Kaifeng
  • Xia, Bobo
  • Guo, Zhaoxuan

Abstract

We study a consumption-based asset pricing model with ‘good’ and ‘bad’ uncertainties. Good and bad uncertainties are characterized by two gamma distributions with time-varying shape parameters and they respectively represent potentially fat-tailed, skewed positive and negative innovations to consumption growth. The representative agent has generalized disappointment aversion preferences. We show that disappointment aversion is important for generating a low risk-free rate and high equity premium, and additionally, while the influence of the elasticity of intertemporal substitution (EIS) on equity premium is negligible, the EIS is important for delivering reasonable implications on the market prices of the two uncertainty components.

Suggested Citation

  • Li, Kaifeng & Xia, Bobo & Guo, Zhaoxuan, 2021. "A consumption-based asset pricing model with disappointment aversion and uncertainty shocks," Economic Modelling, Elsevier, vol. 94(C), pages 235-243.
    • Handle: RePEc:eee:ecmode:v:94:y:2021:i:c:p:235-243
    DOI: 10.1016/j.econmod.2020.09.016
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    3. Tai-Yuen Hon & Massoud Moslehpour & Kai-Yin Woo, 2021. "Review on Behavioral Finance with Empirical Evidence," Advances in Decision Sciences, Asia University, Taiwan, vol. 25(4), pages 15-41, December.

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    More about this item

    Keywords

    Asset pricing; Consumption growth; Disappointment aversion; Equity premium; Uncertainty;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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