Pagel, Michaela (2012): ExpectationsBased ReferenceDependent Preferences and Asset Pricing.

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Abstract
This paper incorporates expectationsbased referencedependent preferences into the canonical Lucastree assetpricing economy. Expectationsbased loss aversion increases the equity premium and decreases the consumptionwealth ratio, because uncertain fluctuations in consumption are perceived to be more painful. Moreover, because unexpected cuts in consumption are particularly painful, the agent wants to postpone such cuts to let his reference point decrease. Thus, even though shocks are i.i.d., loss aversion induces variation in the consumptionwealth ratio, which generates variation in the equity premium, expected returns, and predictability. The level and variation in the equity premium and the predictability in returns match historical moments, but the associated variation in intertemporal substitution motives results in excessive variation in the riskfree rate. This effect can be partially offset with variation in expected consumption growth, heteroskedasticity in consumption growth, or timevariant disaster risk. As a key contribution, I show that the preferences resolve the equitypremium puzzle and simultaneously imply plausible risk attitudes towards small and large wealth bets.
Item Type:  MPRA Paper 

Original Title:  ExpectationsBased ReferenceDependent Preferences and Asset Pricing 
Language:  English 
Keywords:  expectationsbased referencedependent preferences, asset pricing, equitypremium puzzle, predictability 
Subjects:  D  Microeconomics > D0  General > D03  Behavioral Microeconomics: Underlying Principles G  Financial Economics > G0  General > G02  Behavioral Finance: Underlying Principles G  Financial Economics > G1  General Financial Markets > G12  Asset Pricing ; Trading Volume ; Bond Interest Rates 
Item ID:  47933 
Depositing User:  Michaela Pagel 
Date Deposited:  01 Jul 2013 13:19 
Last Modified:  27 Sep 2019 05:28 
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URI:  https://mpra.ub.unimuenchen.de/id/eprint/47933 