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Risk Aversion and the Labor Margin in Dynamic Equilibrium Models”Federal Reserve Bank of San Francisco working paper

By Eric T. Swanson, I Thank Ivan Jaccard, Martin Schneider, Harald Uhlig, Elmar Mertens, Marcelo Ferman, Jonas Fisher, Edward Nelson, Glenn Rudebusch, John Williams and Seminar Participants


The household’s labor margin has a substantial effect on risk aversion, and hence asset prices, in dynamic equilibrium models even when utility is additively separable between consumption and labor. This paper derives simple, closed-form expressions for risk aversion that take into account the household’s labor margin. Ignoring this margin can wildly overstate the household’s true aversion to risk. Risk premia on assets priced with the stochastic discount factor increase essentially linearly with risk aversion, so measuring risk aversion correctly is crucial for asset pricing in the model. Closed-form expressions for risk aversion in models with generalized recursive preferences and internal and external habits are also derived

Year: 2010
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