On Sources of Risk Premia in Representative Agent Models
31 Pages Posted: 13 Sep 2019 Last revised: 15 Sep 2019
Date Written: September 12, 2019
We use options data and realized returns to decompose unconditional risk premia into different parts of the return state space. Our decomposition shows that states associated with stock market crashes account for most of the equity premium in the data, but for nearly none of it in leading asset pricing theories based on habits, long run risks, and rare disasters. Calibrations with alternative shock specifications suggest that standard risk preferences make it challenging to account for sources of risk premia in a full information representative agent setting. A model with Generalized Disappointment Aversion preferences fits the data well.
Keywords: equity premium decomposition, model diagnostic, return state space, equity index options, generalized disappointment aversion
JEL Classification: G12, G13
Suggested Citation: Suggested Citation