A Microeconomic Explanation of the EPK Paradox

Supported by several recent investigations the empirical pricing kernel paradox might be considered as a stylized fact. In Chabi-Yo et al. (2008) simulation studies have been presented which suggest that this paradox might be caused by regime switching of stock prices in financial markets. Alternatively, we want to emphasize a microeconomic view. Based on an economic model with state dependent utilities for the financial investors we succeed in explaining the paradox by changes of the risk attitudes. Theoretically, the change behaviour is compressed by the pricing kernels. As a starting point for empirical insights we shall develop and investigate inverse problems in terms of data fits for estimated basic values of the pricing kernel.Pricing kernel, representative agent, empirical pricing kernel, epk paradox, state dependent utilities, switching points

A microeconomic explanation of the epk paradox

Supported by some recent investigations the empirical pricing kernel paradox might be viewed as a stylized fact. In ChabiYo et al. (2008) simulation studies have been presented which suggest that this paradox might be caused by regime switching of stock prices in financial markets. Alternatively, we want to emphasize a microeconomic view. Based on an economic model with state dependent utilities for the financial investors we succeed in explaining the paradox by changes of risk attitudes. Theoretically, the change behaviour is compressed in the pricing kernels. As a starting point for empirical insights we shall develop and investigate inverse problems in terms of data fits for estimated basic values of the pricing kernel

Pessimistic beliefs under rational learning: quantitative implications for the equity premium puzzle

In the presence of infrequent but observable structural breaks, we show that a model in which the representative agent is on a rational learning path concerning the real consumption growth process can generate high equity premia and low risk-free interest rates. In fact, when the model is calibrated to U.S. consumption growth data, average risk premia and bond yields similar to those displayed by post- depression (1938-1999) U.S. historical experience are generated for low levels of risk aversion. Even ruling out pessimistic beliefs, recursive learning inflates the equity premium without requiring a strong curvature of the utility function. Simulations reveal that other moments of equilibrium asset returns are easily matched, chiefly excess volatility and the presence of ARCH effects. These findings are robust to a number of details of the simulation experiments, such as the number and dating of the breaks.Assets (Accounting) ; Rational expectations (Economic theory)

Why does Implied Risk Aversion Smile?

A few recent papers have derived estimates of the representative agent's risk aversion by comparing the statistical density of asset returns and the state-price density. The implied risk aversion estimates obtained in these studies are puzzling, exhibiting (i) pronounced U-shaped patterns (a "smile") and (ii) negative values. This paper analyzes three potential explanations for these phenomena: (i) heterogeneity in investor preferences, (ii) difficulties in estimating agents' beliefs and (iii) heterogeneous beliefs among agents. Our results show that preferences alone cannot explain the patterns reported in the literature. Misestimation of investors' beliefs caused by nonstationarity of the return process cannot explain the smile either. The patterns of beliefs misestimation required to generate the empirical implied risk aversion estimates found in the literature suggest that heterogeneous beliefs are the most likely cause of the smile.asset pricing; state-price density; heterogeneous preferences; heterogeneous beliefs; implied risk aversion

Design of a Pure Endowment Life Insurance Contract Based on Optimal Stochastic Control

In this paper, we design a pure-endowment insurance contract and obtain the optimal strategy and consumption for a policyholder with CRRA utility function. In this contract, premiums are received from the policyholder at certain times. Theinsurer undertakes to pay the premiums by a certain guarantee rate, in addition, by investing in a portfolio of risky and risk free assets share invest pro ts. We used Variance Gamma process as a representative of in nite activity jump modelsand sensitivity of jump parameters in an uncertainty  nancial market has been studied. Also we compared results using by two forces of mortality

A Primer on Financial Contagion

This paper presents a unified framework to highlight possible channels for the international transmission of financial shocks. We first review the different definitions and measures of contagion used in the literature. We then use a simple multi-country asset pricing model to cast the main elements of the current debate on contagion and provide a stylized account of how a crisis in one country can spread to the world economy. In particular, the model shows how crises can be transmitted across countries, without assuming market imperfections or DG KRF portfolio management rules. Finally, tracking our classification, we survey the results obtained in the empirical literature on contagion.contagion, financial crisis, contagion

Optimal control of risk process in a regime-switching environment

This paper is concerned with cost optimization of an insurance company. The surplus of the insurance company is modeled by a controlled regime switching diffusion, where the regime switching mechanism provides the fluctuations of the random environment. The goal is to find an optimal control that minimizes the total cost up to a stochastic exit time. A weaker sufficient condition than that of (Fleming and Soner 2006, Section V.2) for the continuity of the value function is obtained. Further, the value function is shown to be a viscosity solution of a Hamilton-Jacobian-Bellman equation.Comment: Keywords: Regime switching diffusion, continuity of the value function, exit time control, viscosity solutio

Earnings and Wealth Inequality and Income Taxation: Quantifying the Trade-Offs of Switching to a Proportional Income Tax in the U.S. Ohio

This papaer quantifies the steady-state aggregate, distributinal and mobility effects of switching the U.S. to a proportional income tax system. As a perriquisite to the analysi, we propose a theory of earnings and wealth inequality capable of accounting quantitatively for the key aggregate and inequality facts of the U. S. economy. This theory is based on saving to smooth uninsured household-specific risk, for dynastic households that also have some life-cycle characteristics. A suitable calibration of our model economy replicates the U.S. growth facts, earnings and wealth distributions, the progressivity of the tax system and the size of the U.S. government. We also solve a similar model economy in which the government livies a proportional income tax to finance the same flow of government expenditures and public transfers. Our finding show that in this class of model worlds a switch from the U.S. tax system to a proporcional tax system implies the following trade-offs, i.) it increases efficiency as measured by aggregate output by 4,4%, ii. ) it increases inequality as measured by the Gini index of the wealth distribution by 10.4%, and iv.) it changes by little the mobility between the different earnings and wealth groups