Reference

Marco Bonomo, René Garcia, Nour Meddahi, and Roméo Tédongap, Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices, TSE Working Paper, n. 10-187, June 2010.

Abstract

We propose an asset pricing model where preferences display generalized disappointment aversion (Routledge and Zin, 2009) and the endowment process involves long-run volatility risk. These preferences, which are embedded in the Epstein and Zin (1989) recursive utility framework, overweight disappointing results as compared to expected utility, and display relatively larger risk aversion for small gambles. With a Markov switching model for the endowment process, we derive closed-form solutions for all returns moments and predictability regressions. The model produces first and second moments of price-dividend ratios and asset returns and return predictability patterns in line with the data. Compared to Bansal and Yaron (2004), we generate: i) more predictability of excess returns by price-dividend ratios; ii) less predictability of consumption growth rates by price-dividend ratios. Differently from the Bansal and Yaron model, our results do not depend on a value of the elasticity of intertemporal substitution greater than one.

JEL codes

  • G1: General Financial Markets
  • G12: Asset Pricing • Trading Volume • Bond Interest Rates
  • G11: Portfolio Choice • Investment Decisions
  • C1: Econometric and Statistical Methods and Methodology: General
  • C5: Econometric Modeling
  • Replaced by

    Marco Bonomo, René Garcia, Nour Meddahi, and Roméo Tédongap, Generalized Disappointment Aversion, Long Run Volatility Risk and Asset Prices, The Review of Financial Studies, vol. 24, n. 1, 2011, pp. 82–122.