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Random Risk Appetite

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  • Samih Antoine Azar

Abstract

There is a burgeoning literature on the randomness of the coefficient of relative risk aversion (CRRA). This paper is in line with such a research agenda. Modelling risk aversion, or its converse, risk appetite, as a random variable violates one of the fundamental principles of economics, in general, and of the behavior under risk in particular, and which is constant preferences. This paper argues otherwise. Both conditional and unconditional tests are carried out to identify the CRRA. A battery of econometric procedures is attempted. The paper postulates that the CRRA follows a normal distribution, with the first two statistical moments derived from the empirical results. The CRRA is found to follow a normal distribution with mean 2.57, and with a standard error of 0.454. Surprisingly, the 95% confidence interval does not include a CRRA of +1, or log utility. However the richness of the approach compensates for this caveat.

Suggested Citation

  • Samih Antoine Azar, 2018. "Random Risk Appetite," Research in Applied Economics, Macrothink Institute, vol. 10(3), pages 52-68, September.
    • Handle: RePEc:mth:raee88:v:10:y:2018:i:3:p:52-68
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    References listed on IDEAS

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    1. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-131, February.
    2. Dave Berger & H. J. Turtle, 2009. "Time Variability In Market Risk Aversion," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 32(3), pages 285-307, September.
    3. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, April.
    4. Kocherlakota, Narayana R., 1990. "On the 'discount' factor in growth economies," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 43-47, January.
    5. Samih Antoine Azar & Vera Karaguezian-Haddad, 2014. "Simulating the market coefficient of relative risk aversion," Cogent Economics & Finance, Taylor & Francis Journals, vol. 2(1), pages 1-7, December.
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