IDEAS home Printed from https://ideas.repec.org/a/eee/matsoc/v101y2019icp41-46.html
   My bibliography  Save this article

Preferences with taste shock representations: Price volatility and the liquidity premium

Author

Listed:
  • Krishna, R. Vijay
  • Sadowski, Philipp

Abstract

If price volatility is caused in some part by taste shocks, then it should be positively correlated with the liquidity premium. Our argument is based on Krishna and Sadowski (2014), who provide foundations for a representation of dynamic choice with taste shocks, and show that volatility in tastes corresponds to a desire to maintain flexibility. To formally connect volatile tastes to price volatility and preference for flexibility to the liquidity premium, we analyze a modified simple Lucas tree economy with two otherwise identical assets, where one provides more liquidity because its output can be traded on an auxiliary international market, and where the representative agent is uncertain about his degree of future risk aversion. We show that a representative agent with a higher degree of uncertainty about his future risk aversion implies a higher liquidity premium (ie, a higher price for the more liquid asset) and more price volatility.

Suggested Citation

  • Krishna, R. Vijay & Sadowski, Philipp, 2019. "Preferences with taste shock representations: Price volatility and the liquidity premium," Mathematical Social Sciences, Elsevier, vol. 101(C), pages 41-46.
    • Handle: RePEc:eee:matsoc:v:101:y:2019:i:c:p:41-46
    DOI: 10.1016/j.mathsocsci.2019.06.004
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0165489619300514
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.mathsocsci.2019.06.004?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Bansal, Ravi & Coleman, Wilbur John, II, 1996. "A Monetary Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Journal of Political Economy, University of Chicago Press, vol. 104(6), pages 1135-1171, December.
    2. Prescott, Edward C & Townsend, Robert M, 1984. "General Competitive Analysis in an Economy with Private Information," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 1-20, February.
    3. Stefan Nagel, 2012. "Evaporating Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 25(7), pages 2005-2039.
    4. Faruk Gul & Wolfgang Pesendorfer, 2004. "Self-Control and the Theory of Consumption," Econometrica, Econometric Society, vol. 72(1), pages 119-158, January.
    5. Bekaert, Geert & Engstrom, Eric & Grenadier, Steven R., 2010. "Stock and bond returns with Moody Investors," Journal of Empirical Finance, Elsevier, vol. 17(5), pages 867-894, December.
    6. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
    7. Prescott, Edward C & Townsend, Robert M, 1984. "Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard," Econometrica, Econometric Society, vol. 52(1), pages 21-45, January.
    8. R. Vijay Krishna & Philipp Sadowski, 2014. "Dynamic Preference for Flexibility," Econometrica, Econometric Society, vol. 82(2), pages 655-703, March.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Krishna, R. Vijay & Sadowski, Philipp, 2021. "Randomly evolving tastes and delayed commitment," Journal of Mathematical Economics, Elsevier, vol. 92(C), pages 81-94.
    2. Yariv, Leeat & Jackson, Matthew O., 2018. "The Non-Existence of Representative Agents," CEPR Discussion Papers 13397, C.E.P.R. Discussion Papers.
    3. Garratt, Rod & Keister, Todd & Qin, Cheng-Zhong & Shell, Karl, 2002. "Equilibrium Prices When the Sunspot Variable Is Continuous," Journal of Economic Theory, Elsevier, vol. 107(1), pages 11-38, November.
    4. Mira Frick & Ryota Iijima & Tomasz Strzalecki, 2019. "Dynamic Random Utility," Econometrica, Econometric Society, vol. 87(6), pages 1941-2002, November.
    5. Geert Bekaert & Seonghoon Cho & Antonio Moreno, 2010. "New Keynesian Macroeconomics and the Term Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(1), pages 33-62, February.
    6. Forges, Francoise & Minelli, Enrico & Vohra, Rajiv, 2002. "Incentives and the core of an exchange economy: a survey," Journal of Mathematical Economics, Elsevier, vol. 38(1-2), pages 1-41, September.
    7. Lagos, Ricardo, 2010. "Asset prices and liquidity in an exchange economy," Journal of Monetary Economics, Elsevier, vol. 57(8), pages 913-930, November.
    8. Marco Airaudo, 2017. "Complex stock price dynamics under Max Weber’s spirit of capitalism hypothesis," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 64(1), pages 47-73, June.
    9. Hanno Lustig & Stijn Van Nieuwerburgh & Adrien Verdelhan, 2013. "The Wealth-Consumption Ratio," The Review of Asset Pricing Studies, Society for Financial Studies, vol. 3(1), pages 38-94.
    10. Bekaert, Geert & Engstrom, Eric & Xing, Yuhang, 2009. "Risk, uncertainty, and asset prices," Journal of Financial Economics, Elsevier, vol. 91(1), pages 59-82, January.
    11. Martine Quinzii & Michael Magill, 2005. "An Equilibrium Model of Managerial Compensation," Working Papers 120, University of California, Davis, Department of Economics.
    12. Scheffel, Eric, 2008. "A Credit-Banking Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Cardiff Economics Working Papers E2008/30, Cardiff University, Cardiff Business School, Economics Section.
    13. Kim, Yun-Yeong, 2021. "Composite-asset-risk approach to solving the equity premium puzzle," International Review of Economics & Finance, Elsevier, vol. 71(C), pages 200-216.
    14. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(4), pages 865-888.
    15. Enrico Minelli & Heracles M. Polemarchakis, 1999. "Nash-walras Equilibria of a Large Economy," Working Papers hal-00601580, HAL.
    16. Harold Cole & Felix Kubler, 2012. "Recursive Contracts, Lotteries and Weakly Concave Pareto Sets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(4), pages 479-500, October.
    17. Edward C. Prescott & Richard Rogerson & Johanna Wallenius, 2009. "Lifetime Aggregate Labor Supply with Endogenous Workweek Length," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(1), pages 23-36, January.
    18. Rubens Penha Cysne, 2005. "Equity-Premium Puzzle: Evidence From Brazilian Data," Anais do XXXIII Encontro Nacional de Economia [Proceedings of the 33rd Brazilian Economics Meeting] 088, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].
    19. Herakles Polemarchakis, 2015. "Markets and Efficiency," The Japanese Economic Review, Japanese Economic Association, vol. 66(2), pages 150-166, June.
    20. Boyd, John H. & Prescott, Edward C., 1986. "Financial intermediary-coalitions," Journal of Economic Theory, Elsevier, vol. 38(2), pages 211-232, April.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:matsoc:v:101:y:2019:i:c:p:41-46. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/505565 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.