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Counter-cyclical risk aversion

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  • Kim, Kun Ho
Abstract
The paper proposes a consistent estimator of time-varying risk aversion in consumption-based CAPM. Based on the Epstein–Zin–Weil (Epstein and Zin, 1989, 1991; Weil, 1989) recursive utility, we derive the Euler equation in which risk aversion is a non-parametric function of time. The proxy variable method is utilized to replace the unobserved return to aggregate wealth in the Euler equation. The estimation of risk aversion is carried out based on a two-stage local-linear regression method. Given the estimate, we investigate the conventional wisdom in economics that risk aversion is counter-cyclical. The empirical results strongly support the counter-cyclicality of the risk aversion parameter.

Suggested Citation

  • Kim, Kun Ho, 2014. "Counter-cyclical risk aversion," Journal of Empirical Finance, Elsevier, vol. 29(C), pages 384-401.
    • Handle: RePEc:eee:empfin:v:29:y:2014:i:c:p:384-401
    DOI: 10.1016/j.jempfin.2014.09.005
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    Cited by:

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    2. Dominique Pépin & Stephen Miller, 2020. "The Time-Varying Nature of Risk Aversion: Evidence from 60 Years of U.S. Stock Market Data," Post-Print hal-04648224, HAL.
    3. Xu, Xin & Xu, Xiaoguang, 2023. "Monetary policy transmission modeling and policy responses," The North American Journal of Economics and Finance, Elsevier, vol. 64(C).
    4. Massimo Guidolin & Erwin Hansen & Gabriel Cabrera, 2023. "Time-Varying Risk Aversion and International Stock Returns," BAFFI CAREFIN Working Papers 23203, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    5. Jonathan Dark & Xin Gao & Thijs van der Heijden & Federico Nardari, 2022. "Forecasting variance swap payoffs," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(12), pages 2135-2164, December.
    6. Zhu, Chao & Zhang, Yuwei & Yi, Zhen, 2021. "The high frequency risk attitude implied by the volatility risk premium," Economics Letters, Elsevier, vol. 207(C).
    7. Azam Mohammadzadeh & Mohammad Nabi Shahiki Tash & Reza Roshan, 2016. "Investigating and Comparing Some Consumption-based Asset Pricing Models: The Case of Iran," International Journal of Economics and Financial Issues, Econjournals, vol. 6(4), pages 1884-1894.
    8. Kim, Kun Ho & Kim, Taejin, 2016. "Capital asset pricing model: A time-varying volatility approach," Journal of Empirical Finance, Elsevier, vol. 37(C), pages 268-281.
    9. Baillie, Richard T. & Kim, Kun Ho, 2015. "Was it risk? Or was it fundamentals? Explaining excess currency returns with kernel smoothed regressions," Journal of Empirical Finance, Elsevier, vol. 34(C), pages 99-111.
    10. Dominique Pépin & Stephen Miller, 2020. "The Time-Varying Nature of Risk Aversion: Evidence from 60 Years of U.S. Stock Market Data," Post-Print hal-04648224, HAL.

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    More about this item

    Keywords

    Consumption-based capital asset pricing model; Time-varying risk aversion; Two-stage local linear regression; Consistency; Local-stationarity; Counter-cyclicality;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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