An Irrelevance Theorem for Risk Aversion and Time-Varying Risk

Abstract

Macroeconomic and asset-pricing models are divided: modern risk modeling is rarely found in macroeconomics, and asset pricing is less successful in production economies. This divide can be understood through an irrelevance theorem: risk aversion and time-varying risk are irrelevant for the elasticity of any variable with respect to states that do not directly affect higher moments. Thus, modern risk modeling has little effect on how endogenous variables, including asset prices, respond to standard macroeconomic variables like productivity. We prove irrelevance in a general structure that assumes little beyond a representative agent and verify it in global non-linear projection solutions.

Keywords: Equity Premium Puzzle, Time-Varying Risk Premiums, Risk Aversion, Irrelevance, Volatility Puzzle, Business Cycles

JEL Classification: G12, E32