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Substitution, risk aversion, taste shocks and equity premia

✍ Scribed by Michel Normandin; Pascal St-Amour

Publisher
John Wiley and Sons
Year
1998
Tongue
English
Weight
206 KB
Volume
13
Category
Article
ISSN
0883-7252

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✦ Synopsis

This paper gauges the relative contribution of risk aversion, inter-temporal substitution and taste shocks on postwar monthly US equity premia. The time-varying consumption, market, and taste risks involved in the Euler equations are recovered from a common factor GARCH process and the MLE are obtained by applying the Kalman ®lter. Empirically, (1) the market risk is the only source of risk that does not statistically aect the equity premia, and thus, the hypothesis that the coecient of relative risk aversion corresponds to the reciprocal of the elasticity of inter-temporal substitution is not rejected; (2) the estimates are reasonable, so that the equity premium puzzle is circumvented; and (3) taste risks are quantitatively important in capturing excess returns movements.

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