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Substitution, Risk Aversion and Asset Prices: An Expected Utility Approach

dc.contributor.authorEden, Benjamin
dc.description.abstractThe standard power utility function is widely used to explain asset prices. It assumes that the coefficient of relative risk aversion is the inverse of the elasticity of substitution. Here I use the Kihlstrom and Mirman (1974) expected utility approach to relax this assumption. I use time consistent preferences that lead to time consistent plans. In our examples, the past does not matter much for current portfolio decisions. The risk aversion parameter can be inferred from experiments and introspections about bets in terms of permanent consumption (wealth). Evidence about the change in the attitude towards bets over the life cycle may also restrict the value of the risk aversion parameter. Monotonic transformations of the standard power utility function do not change the predictions about asset prices by much. Both the elasticity of substitution and risk aversion play a role in determining the equity premium.
dc.publisherVanderbilt Universityen
dc.subjectConsumption smoothing
dc.subjectintertemporal elasticity of substitution
dc.subjectrisk aversion
dc.subjectasset prices
dc.subjectequity premium
dc.subjectJEL Classification Number: D11
dc.subjectJEL Classification Number: D81
dc.subjectJEL Classification Number: D91
dc.subjectJEL Classification Number: G12
dc.titleSubstitution, Risk Aversion and Asset Prices: An Expected Utility Approach
dc.typeWorking Paperen

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