de Farias Neto, Joao Jose (2008): S-shaped utility, subprime crash and the black swan.
Download (734Kb) | Preview
I propose an S-shaped utility function of consumption which, combined with an heterogeneous agents and external habit setting, fits well the first order moments of the American financial and macroeconomic time series relevant for the equity premium puzzle in the second half of XX century. The average relative risk aversion of the agents remains in the 0-3 range. A "black swan"-kind phenomenon makes two of the 50 years considered (the two oil shocks) responsible for half the average of the stochastic discount factor, thus bringing the annual subjective discount factor to a very low level, around 0.5, which solves the risk-free puzzle. The shape of the relative risk aversion function of consumption suggests an explanation for the 2008 suprime crash akin to the breaking of waves on a beach in a lifecycle overlapping generations model.
|Item Type:||MPRA Paper|
|Original Title:||S-shaped utility, subprime crash and the black swan|
|Keywords:||financial puzzles; subprime crash; black swan; S-shaped utility|
|Subjects:||G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
D - Microeconomics > D9 - Intertemporal Choice and Growth > D91 - Intertemporal Consumer Choice; Life Cycle Models and Saving
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
|Depositing User:||JOAO JOSE DE FARIAS NETO|
|Date Deposited:||12. Dec 2008 19:54|
|Last Modified:||13. Feb 2013 13:59|
Abel, A. B. (2007). Equity premia with benchmark levels of consumption: closed results. In Handbook of the equity risk premium, Chapter 4. Elsevier.
Belo, F. (2007, November). A pure production-based asset pricing model. Working paper, Carlson School of Management, University of Minnesota.
Benartzi, S. and R. H. Thaler (1995, February). Myopic loss aversion and the equity premium puzzle. Quarterly Journal of Economics 110 (1), 73—92.
Bostian, A. A. (2008, May). Essays on learning and utility in two experiments. Phd thesis, Department of Economics, University of Virginia, Lessburg.
Campbell, J. Y. and J. H. Cochrane (1999, April). By force of habit: A consumption-based explanation of aggregate stock market behavior.
Journal of Political Economy 107(2), 205—251. Cochrane, J. H. (2001). Asset Pricing. Princeton and Oxford: Princeton University Press.
Cysne, R. P. (2006). Equity-premium puzzle: Evidence from brazilian data. Economia Aplicada 10(2), 161—180.
de Farias Neto, J. J. (2007). Utilidades em "S" e os Paradoxos do Mercado Financeiro. Ph. D. thesis, niversidade de São Paulo, FEA, http://www.teses.usp.br/teses/disponiveis/12/12138/tde-24012008-122304/.
Dragulesco, A. and V. Yakovenko (2001). Evidence for the exponential distribution of income in the usa. The European Physical Journal B 20, 585—589.
Friedman, D. (1989, Dec.). The s-shaped value function as a constrained optimum. American Economic Review 79 (5), 1243—1248.
Friedman, M. and J. Savage (1948). The utility analysis of choice involving risk. Journal of Political Economy 56, 279—304.
Gerasymchuk, S. (2007, April). Mean-variance portfolio selection with reference dependent preferences. Working paper 150, Department of Applied Mathematics, University of Venice.
Gerasymchuk, S. (2008, january). Asset return and wealth dynamics with reference dependent preferences and heterogeneous beliefs. Working paper 160, Department of Applied Mathematics, University of Venice.
Hagströmer, B., R. G. Anderson, J. M. Binner, T. Elger, and B. Nilsson (2007, May). Mean-variance vs. full-scale optimization: Broad evidence for the uk. Working paper 016D, Federal Reserve Bank of Saint Louis.
Hamo, Y. and A. Heifetz (2001). An evolutionary perspective on goal seeking and s-shaped utility.Working paper. The Open University of Israel.
Husby, R. (1971, feb.). A nonlinear consumption function estimated from time-series and cross-section data. Review of Economics and Statistics 53(1), 76—79.
Kahneman, D. and A. Tversky (1979, March). Prospect theory: An analysis of decision under risk. Econometrica 47(2), 263—292.
Kimball, M. S. (1990, January). Precautionary saving in the small and in the large. Econometrica 58(1), 53—73.
Levy, H., E. D. Giorgi, and T. Hens (2003, June). Two paradigms and nobel prizes in economics: A contradiction or coexistence? Working paper 161, Institute for Empirical Research in Economics, University of Zurich.
Levy, H. and M. Levy (2004). Prospect theory and mean-variance analysis. The Review of Financial Studies 17(4), 1015—1041.
Markowitz, H. (1952). The utility of wealth. Journal of Political Economy 60, 151—158.
Neilson, W. S. (2002). Comparative risk sensitivity with referencedependent preferences. The Journal of Risk and Uncertainty 24 (2), 131—142.
Netzer, N. (2008, June). Evolution of time preferences and attitudes towards risk. Research paper 29, Thurgau Institute of Economics at the University of Konstanz.
Parker, J. and C. Julliard (2005). Consumption risk and the cross section of expected returns. Journal of Political Economy 113(1), 185—222.
Taleb, E. G. H. . N. N. (2008a, January). Why we have never used the Black-Scholes-Merton option pricing formula. Working paper, NYU-Poly Institute; London Business School, http://ssrn.com/abstract=1012075.
Taleb, N. N. (2008b, February). The Black Swan: The Impact of the Highly Improbable. Penguin Books Uk.
Ternström, I. (2001, january). Cooperation or conflict in common pools. Working Paper Series in Economics and Finance 428, Department of Economics, Stockholm School of Economics.
Tummers, M. P. (1992). Subjective poverty and earnings: five essays. Ph.D. thesis, Katholieke Universiteit Brabant (The Netherlands).
Xi, Y. (2007). Existence of arrow-debreu equilibrium with s-shaped utility function. Acta Mathematicae Applicatae Sinica, English Series 23 (1), 149—154.