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Relative Risk Aversion (relative + risk_aversion)
Kinds of Relative Risk Aversion Selected AbstractsRelative risk aversion, relative prudence and comparative statics under uncertainty: The case of (,, ,)-preferencesBULLETIN OF ECONOMIC RESEARCH, Issue 2 2004Thomas Eichner D81; D21 Abstract From the expected-utility approach, relative risk aversion being smaller than one and relative prudence being smaller than two emerge as preference restrictions that fully determine the optimal responses of decisions under uncertainty to certain shifts in probability distributions. We characterize the magnitudes of relative risk aversion and relative prudence in terms of the two-parameter, mean-standard deviation approach. We demonstrate that this characterization is instrumental in obtaining comparative static results in the two-parameter setting. We further relate our findings to the results in the expected-utility framework. [source] Financial Intermediaries and Interest Rate Risk: IIFINANCIAL MARKETS, INSTITUTIONS & INSTRUMENTS, Issue 5 2006Sotiris K. Staikouras The current work extends and updates the previous survey (Staikouras, 2003) by looking at other aspects of the financial institutions' yield sensitivity. The study starts with an extensive discussion of the origins of asset-liability management and the subsequent work to identify effective ways of measuring and managing interest rate risk. The discussion implicates both regulatory and market-based approaches along with any issues surrounding their applicability. The literature is enriched by recognizing that structural and regulatory shifts affect financial institutions in different ways depending on the size and nature of their activities. It is also noted that such shifts could change the bank's riskiness, and force banks to adjust their balance sheet size by altering their maturity intermediation function. Besides yield changes, market cycles are also held responsible for asymmetric effects on corporate values. Furthermore, nonstandard investigations are considered, where embedded options and basis risk are significant above and beyond the intermediary's rate sensitivity, while shocks to the slope of the yield curve is identified as a new variable. When the discount privilege is modeled as an option, it is shown that its value is incorporated in the equities of qualifying banks. Finally, volatility clustering is further established while constant relative risk aversion is not present in the U.S. market. Although some empirical findings may be quite mixed, there is a general consensus that all forms of systematic risk, risk premia, and the risk-return trade-off do exhibit some form of variability, not only over time but also across corporate sizes and segments. [source] Explaining the characteristics of the power (CRRA) utility familyHEALTH ECONOMICS, Issue 12 2008Peter P. WakkerArticle first published online: 22 JAN 200 Abstract The power family, also known as the family of constant relative risk aversion (CRRA), is the most widely used parametric family for fitting utility functions to data. Its characteristics have, however, been little understood, and have led to numerous misunderstandings. This paper explains these characteristics in a manner accessible to a wide audience. Copyright © 2008 John Wiley & Sons, Ltd. [source] Estimating risk aversion from ascending and sealed-bid auctions: the case of timber auction dataJOURNAL OF APPLIED ECONOMETRICS, Issue 7 2008Jingfeng Lu Estimating bidders' risk aversion in auctions is a challenging problem because of identification issues. This paper takes advantage of bidding data from two auction designs to identify nonparametrically the bidders' utility function within a private value framework. In particular, ascending auction data allow one to recover the latent distribution of private values, while first-price sealed-bid auction data allow one to recover the bidders' utility function. This leads to a nonparametric estimator. An application to the US Forest Service timber auctions is proposed. Estimated utility functions display concavity, which can be partly captured by constant relative risk aversion. Copyright © 2008 John Wiley & Sons, Ltd. [source] Portfolio Choice and Life Insurance: The CRRA CaseJOURNAL OF RISK AND INSURANCE, Issue 4 2008Huaxiong Huang We solve a portfolio choice problem that includes life insurance and labor income under constant relative risk aversion (CRRA) preferences. We focus on the correlation between the dynamics of human capital and financial capital and model the utility of the family as opposed to separating consumption and bequest. We simplify the underlying Hamilton,Jacobi,Bellman equation using a similarity reduction technique that leads to an efficient numerical solution. Households for whom shocks to human capital are negatively correlated with shocks to financial capital should own more life insurance with greater equity/stock exposure. Life insurance hedges human capital and is insensitive to the family's risk aversion, consistent with practitioner guidance. [source] Bounds on Derivative Prices in an Intertemporal Setting with Proportional Transaction Costs and Multiple SecuritiesMATHEMATICAL FINANCE, Issue 3 2001George M. Constantinides The observed discrepancies of derivative prices from their theoretical, arbitrage-free values are examined in the presence of transaction costs. Analytic upper and lower bounds on the reservation write and purchase prices, respectively, are obtained when an investor's preferences exhibit constant relative risk aversion between zero and one. The economy consists of multiple primary securities with stationary returns, a constant rate of interest, and any number of American or European derivatives with, possibly, path-dependent arbitrary payoffs. [source] Yet Another View on Why a Home Is One's CastleREAL ESTATE ECONOMICS, Issue 1 2009Fuad Hasanov We compute equity-based real after-tax rates of return for homeowners and landlords in the United States for 1952,2005. The study confirms that a combined aggregate for residential housing provides a high average net return and low volatility, has low correlation with financial assets and can provide hedge against inflation. The efficient frontier analysis shows that the optimal portfolio for a household with a coefficient of relative risk aversion of four to five is one which contains a bit larger amount of housing than stocks, close to what one observes in the real world. [source] Household Heterogeneity and Real Exchange Rates,THE ECONOMIC JOURNAL, Issue 519 2007Narayana R. Kocherlakota We assume that individuals can fully insure themselves against cross-country shocks but not against individual-specific shocks. We consider two particular models of limited risk-sharing: domestically incomplete markets (DI) and private information,Pareto optimal (PIPO) risk-sharing. For each model, we derive a restriction relating the cross-sectional distributions of consumption and real exchange rates. We evaluate these restrictions using household-level consumption data from the US and the UK. We show that the PIPO restriction fits the data well when households have a coefficient of relative risk aversion of around 5. The restrictions implied by the complete risk-sharing model and the DI model fare poorly. [source] High-Water Marks: High Risk Appetites?THE JOURNAL OF FINANCE, Issue 1 2009Convex Compensation, Long Horizons, Portfolio Choice ABSTRACT We study the portfolio choice of hedge fund managers who are compensated by high-water mark contracts. We find that even risk-neutral managers do not place unbounded weights on risky assets, despite option-like contracts. Instead, they place a constant fraction of funds in a mean-variance efficient portfolio and the rest in the riskless asset, acting as would constant relative risk aversion (CRRA) investors. This result is a direct consequence of the in(de)finite horizon of the contract. We show that the risk-seeking incentives of option-like contracts rely on combining finite horizons and convex compensation schemes rather than on convexity alone. [source] Uncovering the Risk,Return Relation in the Stock MarketTHE JOURNAL OF FINANCE, Issue 3 2006HUI GUO ABSTRACT There is ongoing debate about the apparent weak or negative relation between risk (conditional variance) and expected returns in the aggregate stock market. We develop and estimate an empirical model based on the intertemporal capital asset pricing model (ICAPM) that separately identifies the two components of expected returns, namely, the risk component and the component due to the desire to hedge changes in investment opportunities. The estimated coefficient of relative risk aversion is positive, statistically significant, and reasonable in magnitude. However, expected returns are driven primarily by the hedge component. The omission of this component is partly responsible for the existing contradictory results. [source] Option-Implied Risk Aversion EstimatesTHE JOURNAL OF FINANCE, Issue 1 2004Robert R. Bliss ABSTRACT Using a utility function to adjust the risk-neutral PDF embedded in cross sections of options, we obtain measures of the risk aversion implied in option prices. Using FTSE 100 and S&P 500 options, and both power and exponential-utility functions, we estimate the representative agent's relative risk aversion (RRA) at different horizons. The estimated coefficients of RRA are all reasonable. The RRA estimates are remarkably consistent across utility functions and across markets for given horizons. The degree of RRA declines broadly with the forecast horizon and is lower during periods of high market volatility. [source] Valuation of housing index derivativesTHE JOURNAL OF FUTURES MARKETS, Issue 7 2010Melanie Cao This study analyzes the valuation of housing index derivatives traded on the Chicago Mercantile Exchange (CME). Specifically, to circumvent the nontradability of housing indices, we propose and implement an equilibrium valuation framework. Assuming a mean-reverting aggregate dividend process and a utility function characterized by constant relative risk aversion, we show that the value of a housing index derivative depends only on parameters characterizing the underlying housing index, the endogenized interest rate and their correlation. We also analytically and numerically examine risk premiums for the CME futures and options and obtain three important findings. First, risk premiums are significant for all contracts with maturities longer than one year. Second, the expected growth rate of the underlying index is the key determinant for risk premiums. Third, risk premiums can be positive or negative, depending on whether the expected growth rate of the underlying index is higher or lower than the risk-free yield-to-maturity. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 30:660,688, 2010 [source] An optimal investment and consumption model with stochastic returnsAPPLIED STOCHASTIC MODELS IN BUSINESS AND INDUSTRY, Issue 1 2009Xikui Wang Abstract We consider a financial market consisting of a risky asset and a riskless one, with a constant or random investment horizon. The interest rate from the riskless asset is constant, but the relative return rate from the risky asset is stochastic with an unknown parameter in its distribution. Following the Bayesian approach, the optimal investment and consumption problem is formulated as a Markov decision process. We incorporate the concept of risk aversion into the model and characterize the optimal strategies for both the power and logarithmic utility functions with a constant relative risk aversion (CRRA). Numerical examples are provided that support the intuition that a higher proportion of investment should be allocated to the risky asset if the mean return rate on the risky asset is higher or the risky asset return rate is less volatile. Copyright © 2008 John Wiley & Sons, Ltd. [source] Pricing Weather Derivatives using a Predicting Power Time Series Process,ASIA-PACIFIC JOURNAL OF FINANCIAL STUDIES, Issue 6 2009Chuang-Chang Chang Abstract This paper extended the Cao-Wei (2004, JFM) model to construct a theoretical model for pricing weather derivatives in two significant ways. One adopted a time series model developed by Campbell and Diebold (2005, JASA) to describe the dynamics of temperature. The advantage of using Campbell and Diebold's time series model to describe the temperature dynamics is that it can not only take the conditional mean of temperature coming from trend, seasonal, and cyclical components but also allow for the conditional variance dynamics. The other purpose of this paper is to use an extended power utility function, instead of Cao and Wei's constant proportional risk aversion (CPRA) utility function. The extended power utility function could exhibit decreasing, constant, and increasing relative risk aversion. Eventually, we find that the prices of weather derivatives can be determined by weather conditions, discount factors, and forward premiums. Additionally, these sources have close relations with some risk aversion parameters. Furthermore, the results are consistent with Cao and Wei's condition under some specific parameter assumptions. [source] Relative risk aversion, relative prudence and comparative statics under uncertainty: The case of (,, ,)-preferencesBULLETIN OF ECONOMIC RESEARCH, Issue 2 2004Thomas Eichner D81; D21 Abstract From the expected-utility approach, relative risk aversion being smaller than one and relative prudence being smaller than two emerge as preference restrictions that fully determine the optimal responses of decisions under uncertainty to certain shifts in probability distributions. We characterize the magnitudes of relative risk aversion and relative prudence in terms of the two-parameter, mean-standard deviation approach. We demonstrate that this characterization is instrumental in obtaining comparative static results in the two-parameter setting. We further relate our findings to the results in the expected-utility framework. [source] | ||||||||||||||||||||||