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Growth uncertainty,generalized disappointment aversion and production-based asset pricing
Affiliation:1. Accounting and Finance Group, Manchester Business School, University of Manchester, Booth Street West, Manchester M15 6PB, UK;2. Department of Economics, Boston University, 270 Bay State Road, Boston MA 02215, USA;3. CEMA, Central University of Finance and Economics, Beijing, China;4. AFR, Zhejiang University, Hangzhou, China;1. School of Economics, Fudan University, China;2. School of Economics and Key Laboratory of Mathematical Economics, Shanghai University of Finance and Economics, China;1. PUC-Rio, Brazil;2. Federal Reserve Bank of Richmond, United States;1. International School of Economics and Management, Capital University of Economics and Business, Beijing, China;2. University of California, Department of Economics, Santa Barbara, CA 93106, United States;1. Peterson Institute for International Economics, 1750 Massachusetts Avenue NW, Washington, DC 20036, United States;2. DevTech Systems, Inc., United States;3. University of Michigan, United States;4. Georgetown University, United States
Abstract:We study a production economy with regime switching in the conditional mean and volatility of productivity growth. The representative agent has generalized disappointment aversion (GDA) preferences. We show that volatility risk in productivity growth carries a positive and sizable risk premium in levered equity. Our model can endogenously generate long-run risks in the volatility of consumption growth observed in the data. We show that introducing leverage with a procyclical dividend process consistent with the data is critical for the GDA preferences to have a large impact on equity returns.
Keywords:Equity premium  Asset pricing  Business cycles  Disappointment aversion  Volatility risk  DSGE model  Markov switching
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