The Implications of First-Order Risk Aversion for Asset Market Risk Premiums

50 Pages Posted: 19 Dec 2000  

Geert Bekaert

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Robert J. Hodrick

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

David A. Marshall

Federal Reserve Bank of Chicago; University of Chicago - Booth School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: January 1994

Abstract

Existing general equilibrium models based on traditional expected utility preferences have been unable to explain the excess return predictability observed in equity markets, bond markets, and foreign exchange markets. In this paper, we abandon the expected-utility hypothesis in favor of preferences that exhibit first-order risk aversion. We incorporate these preferences into a general equilibrium two-country monetary model, solve the model numerically, and compare the quantitative implications of the model to estimates obtained from U.S. and Japanese data for equity, bond and foreign exchange markets. Although increasing the degree of first-order risk aversion substantially increases excess return predictability, the model remains incapable of generating excess return predictability sufficiently large to match the data. We conclude that the observed patterns of excess return predictability are unlikely to be explained purely by time-varying risk premiums generated by highly risk averse agents in a complete markets economy.

Suggested Citation

Bekaert, Geert and Hodrick, Robert J. and Marshall, David A., The Implications of First-Order Risk Aversion for Asset Market Risk Premiums (January 1994). NBER Working Paper No. w4624. Available at SSRN: https://ssrn.com/abstract=254002

Geert Bekaert (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
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National Bureau of Economic Research (NBER)

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Robert J. Hodrick

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

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David Aaron Marshall

Federal Reserve Bank of Chicago ( email )

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Chicago, IL 60604-1413
United States
312-322-5111 (Phone)

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
United States

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