Changes in Risk and Asset Prices

23 Pages Posted: 14 May 2001

See all articles by Christian Gollier

Christian Gollier

University of Toulouse 1 - Industrial Economic Institute (IDEI); CESifo (Center for Economic Studies and Ifo Institute)

Harris Schlesinger

University of Alabama; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: March 2001

Abstract

We examine asset prices in a representative-agent model of general equilibrium. Assuming only that individuals are risk averse, we determine conditions on the changes in asset risk that are both necessary and sufficient for the asset price to fall. We show that these conditions neither imply, nor are implied by the conditions for second-degree stochastic dominance. For example, if the payoff on an asset becomes riskier in the sense of second-degree stochastic dominance, the equilibrium price of the asset need not necessarily fall. We further demonstrate how our results can be imbedded into a market that is incomplete in the sense of containing an uninsurable background risk, such as a risk on labor income. We extend our model to show how a miscalibration of the asset risk can lead to a partial explanation of high equity premia (i.e., the "equity premium puzzle").

Keywords: Asset Pricing, Stochastic Dominance, Equity Premium Puzzle

JEL Classification: D51, G12.

Suggested Citation

Gollier, Christian and Schlesinger, Harris, Changes in Risk and Asset Prices (March 2001). CESifo Working Paper Series No. 443. Available at SSRN: https://ssrn.com/abstract=268971

Christian Gollier

University of Toulouse 1 - Industrial Economic Institute (IDEI) ( email )

Manufacture des Tabacs
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CESifo (Center for Economic Studies and Ifo Institute) ( email )

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Munich, DE-81679
Germany

Harris Schlesinger (Contact Author)

University of Alabama ( email )

P.O. Box 870244
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United States
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205-348-0590 (Fax)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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