Equilibrium Asset Pricing with Epstein-Zin and Loss-Averse Investors

47 Pages Posted: 6 Jun 2015 Last revised: 29 Dec 2016

See all articles by Jing Guo

Jing Guo

Columbia University - Fu Foundation School of Engineering and Applied Science

Xue Dong He

The Chinese University of Hong Kong - Department of Systems Engineering and Engineering Management

Date Written: December 27, 2016

Abstract

We study multi-period equilibrium asset pricing in an economy with Epstein-Zin (EZ-) agents whose preferences for consumption are represented by recursive utility and with loss averse (LA-) agents who derive additional utility of gains and losses and are averse to losses. We propose an equilibrium gain-loss ratio for stocks and show that the LA-agents are more (less) risk averse than the EZ-agents if their degree of loss aversion is higher (lower) than this ratio. When all the agents have unitary relative risk aversion degree and elasticity of intertemporal substitution, we prove the existence and uniqueness of the equilibrium and the market dominance of the EZ-agents in the long run. Finally, we extend our results to the case in which the LA-agents use probability weighting in their evaluation of gains and losses.

Keywords: equilibrium asset pricing; heterogeneous agents; recursive utility; prospect theory; loss aversion; gain-loss ratio; market dominance

JEL Classification: D53, G02, G11, G12

Suggested Citation

Guo, Jing and He, Xue Dong, Equilibrium Asset Pricing with Epstein-Zin and Loss-Averse Investors (December 27, 2016). Available at SSRN: https://ssrn.com/abstract=2615235 or http://dx.doi.org/10.2139/ssrn.2615235

Jing Guo (Contact Author)

Columbia University - Fu Foundation School of Engineering and Applied Science ( email )

New York, NY
United States

Xue Dong He

The Chinese University of Hong Kong - Department of Systems Engineering and Engineering Management ( email )

505 William M.W. Mong Engineering Building
The Chinese University of Hong Kong, Shatin, N.T.
Hong Kong
Hong Kong

HOME PAGE: http://https://sites.google.com/site/xuedonghepage/home

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