An Irrelevance Theorem for Risk Aversion and Time-Varying Risk
47 Pages Posted: 24 Mar 2018 Last revised: 19 Aug 2019
Date Written: August 16, 2019
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: Suggested Citation