Belief-dependent Utilities, Aversion to State-uncertainty and Asset Prices

Front Cover
Centre for Economic Policy Research, 2001 - Acciones (Bolsa) - Precios - 62 pages
0 Reviews
This Paper reinterprets standard axioms in choice theory to introduce the concepts of ‘belief dependent’ utility functions and aversion to ‘state-uncertainty’. It shows that this type of preference helps to explain the various stylized facts of asset returns, including a high equity risk premium, a low risk-free rate, a high return volatility, stock return predictability and volatility clustering. In one particular specification consistent with habit formation preferences, I also argue that ‘aversion to state-uncertainty’ gives rise to ‘aversion to long-run risk’, that is, to the uncertainty surrounding the long-run average of future consumption. In order to solve for asset prices and returns under general conditions about the hidden state variable, the Paper also develops a discretization methodology to obtain approximate analytical solutions. In a parsimonious parametrization, I then show that the model calibrated to real consumption generates unconditional moments for asset returns that closely match the empirical ones. Finally, due to the estimated time-variation in the dispersion of the conditional distribution on the drift rate of consumption, the model also generates a time series of conditional return volatility in line with the ex-post integrated volatility of stock returns.

From inside the book

What people are saying - Write a review

We haven't found any reviews in the usual places.


Section 1
Section 2
Section 3

7 other sections not shown

Common terms and phrases

Bibliographic information