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What drives stochastic risk aversion?

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  • Cho, Sungjun

Abstract

This paper examines determinants of stochastic relative risk aversion in conditional asset pricing models. Novel time-series specification tests are proposed as direct extensions of Guo, Wang, and Yang (2013, JMCB)'s model using nonlinear state-space models with heteroskedasticity. I then establish the following facts. First, the surplus consumption ratio implied by the external habit formation model is the most important determinant of relative risk aversion. Second, the CAY of Lettau and Ludvigson (2001a) without a look-ahead bias and the short term interest rate explain part of relative risk aversion. Third, the estimated risk aversion from 1957Q2 to 2010Q3 is countercyclical and positive. Finally, the selected models explain part of the momentum and the financial distress premiums.

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  • Cho, Sungjun, 2014. "What drives stochastic risk aversion?," International Review of Financial Analysis, Elsevier, vol. 34(C), pages 44-63.
    • Handle: RePEc:eee:finana:v:34:y:2014:i:c:p:44-63
    DOI: 10.1016/j.irfa.2014.05.006
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    Keywords

    Time-varying relative risk aversion; ICAPM; Nonlinear state-space model with GARCH;
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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