Smooth nonexpected utility without state independence

We propose a notion of smoothness of nonexpected utility functions, which extends the variational analysis of nonexpected utility functions to more general settings. In particular, our theory applies to state dependent utilities, as well as the multiple prior expected utility model, both of which are not possible in previous literatures. Other nonexpected utility models are shown to satisfy smoothness under more general conditions than the Fréchet and Gateaux differentiability used in the literature. We give more general characterizations of monotonicity and risk aversion without assuming state independence of utility function.

Information acquisition and the pre-announcement drift

We present a dynamic Grossman-Stiglitz model with endogenous information acquisition to explain the pre-FOMC announcement drift. Because FOMC announcements reveal substantial information about the economy, investors’ incentives to acquire information are particularly strong days ahead of the announcements. Information acquisition partially resolves the uncertainty for uninformed traders, and under generalized risk sensitive preferences (Ai and Bansal, 2018), lower the discount rate and results in a stock market run-up. Because our theory does not rely on the leakage of information, it can simultaneously explain the low realized volatility during the pre-FOMC announcement period and the lack of a positive correlation between pre-and post-announcement returns.https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3964349First author draf

Information-driven volatility

Modern asset pricing theory predicts an unambiguously positive relationship between volatility and expected returns. Empirically, however, realized volatility in the past often predicts expected returns in the future with a negative sign, as exemplified by the volatility-managed portfolios of Moreira and Muir (2017). Theoretically, we show that information-driven volatility induces a negative correlation between past realized volatility and expected volatility and expected returns in the future. We develop a simple asset pricing model based on this intuition and demonstrate that our model can account for several volatility-related asset pricing puzzles such as the return on volatility managed portfolios, the “variance risk premium” return predictability (Bollerslev, Tauchen, and Zhou, 2009), and the predictability of returns by implied volatility reduction on macroeconomic announcement days.https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3961096First author draf

The cross section of the monetary policy announcement premium

Using the expected option-implied variance reduction to measure the sensitivity of stock returns to monetary policy announcement surprises, this paper shows monetary policy announcements require significant risk compensation in the cross section of equity returns. We develop a parsimonious equilibrium model in which FOMC announcements reveal the Federal Reserve’s private information about its interest-rate target, which affects the private sector’s expectation about the long-run growth-rate of the economy. Our model accounts for the dynamics of implied variances and the cross section of the monetary policy announcement premium realized around FOMC announcement days.Accepted manuscrip

Information Quality and Long-Run Risk: Asset Pricing Implications

I study the asset pricing implications of the quality of public information about persistent productivity shocks in a general equilibrium model with Kreps-Porteus preferences. Low information quality is associated with a high equity premium, a low volatility of consumption growth, and a low volatility of the risk-free interest rate. The relationship between information quality and the equity premium differs from that in endowment economies. My calibration improves substantially upon the Bansal-Yaron model in terms of the moments of the wealth-consumption ratio and the return on aggregate wealth. Copyright (c) 2010 the American Finance Association.

A Theory of Risk Aversion without the Independence Axiom

I study preferences defined on the set of real valued random variables as a model of economic behavior under uncertainty. It is well-known that under the Independence Axiom, the utility functional has an expected utility representation. However, the Independence Aiom is often found contradictory to empirical evidences. The purpose of this paper is to study risk averse utility functions without assuming the Independence Axiom. The major difference between the approach in this paper and that in the literature is I take the point of that prference are defined on set of random variables, in stead of on probability distribution functions. This approach gives simple characterizations of risk aversion, which cannot be expressed when preference is viewd as defined on probability distribution functions. The second advantage is that the differentiability property of utility function studied in this paper does not rely on the assumption that the random variable is bounded (which has to be assumed if one require the utility function is Frechet differentiable in probability distributions). Considering the importance of the tools developed in continuous time asset pricing theory where asset prices are driven by diffusion process, which is clearly not bounded, this approach looks promising in applying nonexpected utility analysis to asset pricing theories. The first part of the paper studies the relation between convexity of preference and risk aversion. When utility function does not have an expected utility representation, equivalence between convexity and risk aversion breaks down. I showed that under appropriate continuity conditions, risk aversion can be characterized by a simple condition that is weaker than convexity, which I call equal-distribution convexity, that is a preference is risk averse iff convex combinations of random variables with the same distribution are preferred to the random variables themselves. Differential properties of risk averse utility functionals are studied. A representation theorem for the form of the Frechet derivative of continuously differentiable utility functionals is given. Characterization of monotonicity and risk aversion in terms of the Frechet derivative of utility functionals are given. I also provide a criteria of comparing individual's attitude toward risk by the properties of the Frechet differential of the utility functions. This criteria, when applied to expected utility, reduces to the usual Arrow-Platt measure of absolute risk aversion. The last part compares the notion of Machina (1982)'s differentiability and the notion of differentiability proposed in this paperRisk Aversion, Non-expected Utility