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Risk aversion, the labor margin, and asset pricing in DSGE models

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  • Eric T. Swanson

Abstract

In dynamic stochastic general equilibrium (DSGE) models, the household's labor margin as well as consumption margin affects Arrow-Pratt risk aversion. This paper derives simple, closed-form expressions for risk aversion that take into account the household's labor margin. Ignoring the labor margin can lead to wildly inaccurate measures of the household's true attitudes toward risk. We show that risk premia on assets computed using the stochastic discount factor are proportional to Arrow-Pratt risk aversion, so that measuring risk aversion correctly is crucial for understanding asset prices. Closed-form expressions for risk aversion in DSGE models with generalized recursive preferences and internal and external habits are also derived.

Suggested Citation

  • Eric T. Swanson, 2009. "Risk aversion, the labor margin, and asset pricing in DSGE models," Working Paper Series 2009-26, Federal Reserve Bank of San Francisco.
    • Handle: RePEc:fip:fedfwp:2009-26
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    Cited by:

    1. Ferman, Marcelo, 2011. "Switching Monetary Policy Regimes and the Nominal Term Structure," Dynare Working Papers 5, CEPREMAP.
    2. van Binsbergen, Jules H. & Fernández-Villaverde, Jesús & Koijen, Ralph S.J. & Rubio-Ramírez, Juan, 2012. "The term structure of interest rates in a DSGE model with recursive preferences," Journal of Monetary Economics, Elsevier, vol. 59(7), pages 634-648.
    3. Gourio, François & Siemer, Michael & Verdelhan, Adrien, 2013. "International risk cycles," Journal of International Economics, Elsevier, vol. 89(2), pages 471-484.
    4. Hakon Tretvoll, 2012. "Real exchange rate variability in a two country business cycle model," 2012 Meeting Papers 911, Society for Economic Dynamics.
    5. Gourio, François, 2012. "Macroeconomic implications of time-varying risk premia," Working Paper Series 1463, European Central Bank.
    6. Bluwstein, Kristina & Yung, Julieta, 2019. "Back to the real economy: the effects of risk perception shocks on the term premium and bank lending," Bank of England working papers 806, Bank of England.

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    Keywords

    Financial risk management; Asset pricing;

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