Are More Risk-Averse Agents More Optimistic? Insights from a Simple Rational Expectations Equilibrium Model

Abstract:     
We analyze the link between pessimism and risk-aversion. We consider a model of partially revealing, competitive rational expectations equilibrium with diverse information, in which the distribution of risk-aversion across individuals is unknown. We show that when a high individual level of risk-aversion is taken as a signal for a high average level of risk-aversion, more risk-averse agents are more optimistic. This correlation between individual risk-aversion and optimism leads to a pessimistic consensus belief hence to an increase in the market price of risk. Risk-sharing schemes and welfare implications are analyzed. We show that agents' welfare may increase upon the receipt of more precise information.

Number of Pages in PDF File: 51

Keywords: Optimism, risk-aversion, rational expectations, risk-premium, heterogenous beliefs

JEL Classification: G12, D53, D82

working papers series