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Measuring relative risk aversion

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  • Samih Antoine Azar

Abstract

This note intends to estimate the Coefficient of Relative Risk Aversion (CRRA). The underlying model is expected utility and certainty equivalence. The utility function selected is of the power form and is shown to be independent of initial wealth. This property makes the results applicable to any individual, whatever her initial wealth, or even to a market measure. The equity premium that the CRRA must explain is calculated to be 9.5%. The CRRA is calibrated by assuming six different economies from an economy with two states of nature to an economy with seven states of nature, that all describe the same distribution of returns. The calibrated CRRAs are between 4.2 and 5.4. Running 100 replications of samples of 6000 observations of the risky outcome shows that the CRRA that satisfies the constraint on the equity premium is 4.5, a figure which is reasonable and plausible.

Suggested Citation

  • Samih Antoine Azar, 2006. "Measuring relative risk aversion," Applied Financial Economics Letters, Taylor & Francis Journals, vol. 2(5), pages 341-345.
    • Handle: RePEc:taf:raflxx:v:2:y:2006:i:5:p:341-345
    DOI: 10.1080/17446540600690151
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    Cited by:

    1. Wade Pfau, 2011. "An optimizing framework for the glide paths of life cycle asset allocation funds," Applied Economics Letters, Taylor & Francis Journals, vol. 18(1), pages 55-58.
    2. 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.
    3. Josa-Fombellida, Ricardo & López-Casado, Paula, 2023. "A defined benefit pension plan game with Brownian and Poisson jumps uncertainty," European Journal of Operational Research, Elsevier, vol. 310(3), pages 1294-1311.
    4. Wade D. Pfau, 2012. "Long-term investors and valuation-based asset allocation," Applied Financial Economics, Taylor & Francis Journals, vol. 22(16), pages 1343-1353, August.
    5. Reus, Lorenzo, 2024. "The integral of the squared Gaussian process," Chaos, Solitons & Fractals, Elsevier, vol. 179(C).
    6. Guohui Guan & Qitao Huang & Zongxia Liang & Fengyi Yuan, 2020. "Retirement decision with addictive habit persistence in a jump diffusion market," Papers 2011.10166, arXiv.org, revised Feb 2024.

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