State Dependence Can Explain the Risk Aversion Puzzle

Risk aversion functions extracted from observed stock and option prices can be negative as shown by Aït-Sahalia and Lo (2000) and Jackwerth (2000).

Author(s):

Fousseni Chabi-Yo

Bank of Canada

Rene Garcia

EDHEC Business School

Eric Renault

University of North Carolina at Chapel Hill, CIREQ and CIRANO

We rationalize this puzzle by a lack of conditioning on latent state variables. Once properly conditioned, risk aversion functions and pricing kernels are consistent with economic theory. To differentiate between the various theoretical explanations in terms of heterogeneity of beliefs or preferences, market sentiment, state-dependent utility or regimes in fundamentals, we calibrate several consumption-based asset pricing models to match the empirical pricing kernel and risk aversion functions at different dates and over several years.

Pdf
State Dependence Can Explain the Risk Aversion Puzzle...
(3.23 MB)
Type: Working paper
Date: le 03/09/2007
Research Cluster : Finance

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