Dynamic Choice and Risk Aversion
University of California, San Diego (UCSD) - Rady School of Management
AFA 2002 Atlanta Meetings
This paper solves explicitly a dynamic choice problem for a class of stochastic volatility models. The explicit solution is used to show that intuitions on static choice problems do not apply in a dynamic choice setting. For example, even though the risk premium of the risky asset in the problem is strictly positive, a more risk-averse agent may hold more risky assets, and a risk-averse agent may short (sometimes infinite amount of) a risky asset. I argue that these counter-intuitive results are due to rebalancing. The results suggest that it may be not appropriate to use stock holdings as a proxy for risk aversion.
Number of Pages in PDF File: 30
Keywords: dynamic choice, risk aversion, stochastic volatility
JEL Classification: D1, D4, D9, G0working papers series
Date posted: October 13, 2001
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