On the Consequences of State Dependent Preferences for the Pricing of Financial Assets

FAME Research Paper No. 73

45 Pages Posted: 22 Jul 2003

See all articles by Jean-Pierre Danthine

Jean-Pierre Danthine

University of Lausanne - Institute of Banking and Finance (IBF); Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Christos I. Giannikos

CUNY - Baruch College; CUNY - The Graduate Center

Hany Guirguis

Manhattan College

John B. Donaldson

Columbia Business School - Finance and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: October 2002

Abstract

This paper introduces state dependent utility into the standard Mehra and Prescott (1985) economy by allowing the representative agent's coefficient of relative risk aversion to vary with the underlying economy's growth rate. Existence of equilibrium is proved and its asymptotic properties analyzed. This generalization leads to level dependent marginal rates of substitution, a property that sharply distinguishes this model from the standard construct. For very low coefficients of relative risk aversion, the equilibrium risk free and risky security returns are demonstrated to have volatilities and an associated equity premium that substantially exceed what is found in the data. This provides a contrasting perspective on the classic "equity premium puzzle."

Keywords: state dependent utility, equity premium, equity premium puzzle

JEL Classification: D91, E21, G00, G12

Suggested Citation

Danthine, Jean-Pierre and Giannikos, Christos I. and Guirguis, Hany and Donaldson, John B., On the Consequences of State Dependent Preferences for the Pricing of Financial Assets (October 2002). FAME Research Paper No. 73, Available at SSRN: https://ssrn.com/abstract=410722 or http://dx.doi.org/10.2139/ssrn.410722

Jean-Pierre Danthine (Contact Author)

University of Lausanne - Institute of Banking and Finance (IBF) ( email )

Lausanne, 1015
Switzerland
+41 21 692 3485 (Phone)
+41 21 692 3335 (Fax)

HOME PAGE: http://www.hec.unil.ch/jdanthine/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Christos I. Giannikos

CUNY - Baruch College ( email )

Dept. of Eco & Fin
Box B10-225
New York, NY New York 10010
United States
646-312-3492 (Phone)
646-312-3451 (Fax)

CUNY - The Graduate Center ( email )

365 Fifth Avenue
New York,, NY 10016
United States

Hany Guirguis

Manhattan College ( email )

Manhattan College Parkway
Riverdale, NY 10471
United States

John B. Donaldson

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

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