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Mixture-Averse Preferences and Heterogeneous Stock Market Participation

75 Pages Posted: 12 Sep 2016  

Todd Sarver

Duke University - Department of Economics

Date Written: September 9, 2016

Abstract

To study intertemporal decisions under risk, we develop a new recursive model of non-expected-utility preferences. The main axiom of our analysis is called mixture aversion, as it captures a dislike of probabilistic mixtures of lotteries. Our representation for mixture-averse preferences can be interpreted as if an individual optimally selects her risk attitude from some feasible set. The representation includes special cases where the choice of risk attitude takes the form of an optimal selection of a reference point. We analyze the implications of the model for both insurance and investment decisions. The main application of the paper shows that mixture-averse preferences can generate endogenous heterogeneity in equilibrium stock market participation, even when consumers have identical preferences and even among wealthy households.

Keywords: Mixture Aversion, Optimal Risk Attitude, Reference Point, Stock Market Participation, Equity Premium Puzzle

Suggested Citation

Sarver, Todd, Mixture-Averse Preferences and Heterogeneous Stock Market Participation (September 9, 2016). Economic Research Initiatives at Duke (ERID) Working Paper No. 229. Available at SSRN: https://ssrn.com/abstract=2837262

Todd Sarver (Contact Author)

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

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