Measuring Risk Aversion From Excess Returns on a Stock Index / Ray Chou, Robert F. Engle, Alex Kane.

By:

Chou, Ray

Contributor(s):

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w3643.Publication details: Cambridge, Mass. National Bureau of Economic Research 1991.Description: 1 online resource: illustrations (black and white)Subject(s):

E - Macroeconomics and Monetary Economics

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Abstract: We distinguish the measure of risk aversion from the slope coefficient in the linear relationship between the mean excess return on a stock index and its variance. Even when risk aversion is constant, the latter can vary significantly with the relative share of stocks in the risky wealth portfolio, and with the beta of unobserved wealth on stocks. We introduce a statistical model with ARCH disturbances and a time-varying parameter in the mean (TVP ARCH-N). The model decomposes the predictable component in stock returns into two parts: the time-varying price of volatility and the time-varying volatility of returns. The relative share of stocks and the beta of the excluded components of wealth on stocks are instrumented by macroeconomic variables. The ratio of corporate profit over national income and the inflation rate ore found to be important forces in the dynamics of stock price volatility.

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Working Paper	Biblioteca Digital	Colección NBER	nber w3643 (Browse shelf(Opens below))	Not For Loan

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Previous	nber w3640 Actual and Warranted Relations Between Asset Prices /	nber w3641 The Invisible Hand and Modern Welfare Economics /	nber w3642 Price Equilibrium, Efficiency, and Decentralizability in Insurance Markets /	nber w3643 Measuring Risk Aversion From Excess Returns on a Stock Index /	nber w3644 Exchange Rate Volatility and International Prices /	nber w3645 The Enforceability of Private Money Contracts, Market Efficiency, and Technological Change /	nber w3646 Why are Prices Sticky? Preliminary Results from an Interview Study /	Next

March 1991.

We distinguish the measure of risk aversion from the slope coefficient in the linear relationship between the mean excess return on a stock index and its variance. Even when risk aversion is constant, the latter can vary significantly with the relative share of stocks in the risky wealth portfolio, and with the beta of unobserved wealth on stocks. We introduce a statistical model with ARCH disturbances and a time-varying parameter in the mean (TVP ARCH-N). The model decomposes the predictable component in stock returns into two parts: the time-varying price of volatility and the time-varying volatility of returns. The relative share of stocks and the beta of the excluded components of wealth on stocks are instrumented by macroeconomic variables. The ratio of corporate profit over national income and the inflation rate ore found to be important forces in the dynamics of stock price volatility.