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Substitution, Risk Aversion, Taste Shocks and Equity Premia

Author

Listed:
  • Michel Normandin

    (CREFE/UQAM)

  • Pascal St-Amour

    (Univeriste Laval)

Abstract

This paper investigates the testable restrictions on the time-series behavior of equity premia implied by a representative agent model whose state- and time-non separable preferences are subject to taste shocks. The model nests state- and time-separable preferences with and without taste shocks as special cases. Empirically, the linearized Euler equations are estimated through Kalman filtering, allowing for conditional heteroscedasticity via a common factor GARCH process. With or without conditional heteroscedasticity, (i) the hypothesis that preferences are separable cannot be rejected, (ii) taste shocks influences are statistically significant, and (iii) taste shocks yield reasonable estimates of the coefficient of relative risk aversion. This last result occurs because taste shocks reproduce the large observed equity premium by shifting weight away from consumption risk in favor to taste risk. This paper is available at ftp://crefe.dse.uqam.ca/pub/cahiers/cah39.ps The whole WP list is at http://www.er.uqam.ca/nobel/crefe/cahiers.html

Suggested Citation

  • Michel Normandin & Pascal St-Amour, 1996. "Substitution, Risk Aversion, Taste Shocks and Equity Premia," Finance 9607001, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:9607001
    Note: 29 pages, Postscript file
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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