Research and publications

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). 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. A revisited version of this working paper was published in the April 2008 issue of the Review of Financial Studies.

Author(s) :

Fousseni Chabi-Yo, René Garcia, Eric Renault

Summary :

Risk aversion functions extracted from observed stock and option prices can be negative as shown by Aït-Sahalia and Lo (2000) and Jackwerth (2000). 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. A revisited version of this working paper was published in the April 2008 issue of the Review of Financial Studies.

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Type : Working paper
Date : 09/03/2007
Keywords :

Asset Pricing