Equilibrium Market Prices of Risks and Market Risk Aversion in a Complete Stochastic Volatility Model with Habit Formation

Posted: 4 May 2010 Last revised: 18 Oct 2010

See all articles by Qian Han

Qian Han

Xiamen University - Wang Yanan Institute for Studies in Economics (WISE)

Calum G. Turvey

Cornell University - School of Applied Economics and Management

Multiple version iconThere are 2 versions of this paper

Date Written: April 26, 2010

Abstract

Considering a pure exchange economy with habit formation utility, this paper explores the equilibrium relationships between the market pricing kernel, the market prices of risks and the market risk aversion under a continuous time stochastic volatility model completed by liquidly traded put options. We demonstrate with these equilibrium relations that the risk neutral pricing partial differential equation is a restricted version of the fundamental pricing equation provided in Garman (1976). We also show that in this completed market stochastic volatility cannot explain the documented empirical pricing kernel puzzle (Jackwerth (2000)). Instead, a habit formation utility offers a possible explanation of the puzzle. The derived quantitative relation between the market prices of risks and the market risk aversion also provides a new way to extract empirical market risk aversion.

Keywords: Market Price of Risk, Pricing Kernel, Risk Aversion, Habit Formation, Stochastic Volatility Model

JEL Classification: G12

Suggested Citation

Han, Qian and Turvey, Calum G., Equilibrium Market Prices of Risks and Market Risk Aversion in a Complete Stochastic Volatility Model with Habit Formation (April 26, 2010). Available at SSRN: https://ssrn.com/abstract=1598020

Qian Han (Contact Author)

Xiamen University - Wang Yanan Institute for Studies in Economics (WISE) ( email )

A 307, Economics Building
Xiamen, Fujian 361005
China

HOME PAGE: http://www.wise.xmu.edu.cn

Calum G. Turvey

Cornell University - School of Applied Economics and Management ( email )

248 Warren Hall
Ithaca, NY 14853
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
1,012
PlumX Metrics