Generalized Disappointment Aversion and Asset Prices
- Author(s): BRYAN R. ROUTLEDGE, STANLEY E. ZIN
- Published: Jul 15, 2010
- Pages: 1303-1332
- DOI: 10.1111/j.1540-6261.2010.01571.x
We characterize generalized disappointment aversion (GDA) risk preferences that can overweight lower‐tail outcomes relative to expected utility. We show in an endowment economy that recursive utility with GDA risk preferences generates effective risk aversion that is countercyclical. This feature comes from endogenous variation in the probability of disappointment in the representative agent's intertemporal consumption‐saving problem that underlies the asset pricing model. The variation in effective risk aversion produces a large equity premium and a risk‐free rate that is procyclical and has low volatility in an economy with a simple autoregressive endowment‐growth process.