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Generalized Disappointment Aversion and Asset Prices,” NBER working paper 10107

By Bryan R. Routledge, Stanley E. Zin, Bart Lipman, Monika Piazzesi, Uday Rajan and Jacob Sagi

Abstract

We provide an axiomatic model of preferences over atemporal risks that generalizes Gul’s disappointment aversion model by allowing risk aversion to be “first order ” at locations in the state space that do not correspond to certainty. Since the lotteries being valued by an agent in an asset-pricing context are not typically local to certainty, our generalization, when embedded in a dynamic recursive utility model, has important quantitative implications for financial markets. We show that the state-price process, or asset-pricing kernel, in a Lucas-tree economy in which the representative agent has generalized disappointment aversion preferences is consistent with the pricing kernel that resolves the equity-premium puzzle. In addition, we show that risk aversion in our model can be both state-dependent and counter-cyclical, which empirical research has demonstrated is necessary for explaining observed asset-pricing behavior

Topics: Preferences over lotteries, expected utility theory, independence axiom, risk aversion, Arrow-Pratt measures of risk aversion Independence axiom, Asset returns, Risk preference
Year: 2003
OAI identifier: oai:CiteSeerX.psu:10.1.1.197.228
Provided by: CiteSeerX
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