An Irrelevance Theorem for Risk Aversion and Time-Varying Risk

47 Pages Posted: 24 Mar 2018 Last revised: 19 Aug 2019

See all articles by Andrew Y. Chen

Andrew Y. Chen

Board of Governors of the Federal Reserve System

Francisco Palomino

Board of Governors of the Federal Reserve System

Date Written: August 16, 2019

Abstract

Macroeconomic and asset-pricing models are divided: modern risk modeling is rarely found in macroeconomics, and asset pricing is less successful in production economies. This divide can be understood through an irrelevance theorem: risk aversion and time-varying risk are irrelevant for the elasticity of any variable with respect to states that do not directly affect higher moments. Thus, modern risk modeling has little effect on how endogenous variables, including asset prices, respond to standard macroeconomic variables like productivity. We prove irrelevance in a general structure that assumes little beyond a representative agent and verify it in global non-linear projection solutions.

Keywords: Equity Premium Puzzle, Time-Varying Risk Premiums, Risk Aversion, Irrelevance, Volatility Puzzle, Business Cycles

JEL Classification: G12, E32

Suggested Citation

Chen, Andrew Y. and Palomino, Francisco, An Irrelevance Theorem for Risk Aversion and Time-Varying Risk (August 16, 2019). Available at SSRN: https://ssrn.com/abstract=3148254 or http://dx.doi.org/10.2139/ssrn.3148254

Andrew Y. Chen (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-973-6941 (Phone)

HOME PAGE: http://sites.google.com/site/chenandrewy/

Francisco Palomino

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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