Age‐Dependent Increasing Risk Aversion and the Equity Premium Puzzle

36 Pages Posted: 3 Apr 2019

See all articles by Amadeu DaSilva

Amadeu DaSilva

California State University, Fullerton - Department of Finance

Mira Farka

California State University, Fullerton

Christos Giannikos

City University of New York (CUNY)

Date Written: May 2019

Abstract

We introduce a new preference structure—age‐dependent increasing risk aversion (IRA)—in a three‐period overlapping generations model with borrowing constraints, and examine the behavior of equity premium in this framework. We find that IRA preferences generate results that are more consistent with U.S. data for the equity premium, level of savings and portfolio shares, without assuming unreasonable levels of risk aversion. We find that the relative difference between the two risk aversions (how much more risk‐averse old agents are relative to the middle‐aged) matters more than the average risk aversion in the economy (how much more risk‐averse both cohorts are). Our findings are robust with respect to a number of model generalizations.

Keywords: equity premium puzzle, overlapping generations model, increasing risk aversion, portfolio allocation

JEL Classification: D10, E21, G0, G12

Suggested Citation

DaSilva, Amadeu and Farka, Mira and Giannikos, Christos, Age‐Dependent Increasing Risk Aversion and the Equity Premium Puzzle (May 2019). Financial Review, Vol. 54, Issue 2, pp. 377-412, 2019, Available at SSRN: https://ssrn.com/abstract=3364530 or http://dx.doi.org/10.1111/fire.12191

Amadeu DaSilva (Contact Author)

California State University, Fullerton - Department of Finance ( email )

PO Box 34080
Fullerton, CA 92834-9480
United States

Mira Farka

California State University, Fullerton ( email )

800 N State College St
Fullerton, CA 92831
United States

Christos Giannikos

City University of New York (CUNY)

695 Park Avenue
New York, NY 10021
United States

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