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Generalized Disappointment Aversion, Long-run Volatility Risk, and Asset Prices

Marco Bonomo1; René Garcia; Nour Meddahi2; Roméo Tédongap3

1 Fundação Getulio Vargas · 2 Toulouse School of Economics · 3 Stockholm School of Economics

Review of Financial Studies 2011 open access

We propose an asset pricing model where preferences display generalized disappointment aversion 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 Differently from the Bansal and Yaron model, our results do not depend on a value of the elasticity of intertemporal substitution greater than one.

DOI
10.1093/rfs/hhq116
Volume
24 (1)
Pages
82-122
Language
en
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