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First‐Order Risk Aversion, Heterogeneity, and Asset Market Outcomes
Author(s) -
CHAPMAN DAVID A.,
POLKOVNICHENKO VALERY
Publication year - 2009
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2009.01482.x
Subject(s) - economics , capital asset pricing model , asset (computer security) , risk aversion (psychology) , order (exchange) , risk premium , security market line , consumption based capital asset pricing model , expected utility hypothesis , equity premium puzzle , microeconomics , financial economics , finance , computer science , stock market , context (archaeology) , paleontology , computer security , biology
We examine a wide range of two‐date economies populated by heterogeneous agents with the most common forms of nonexpected utility preferences used in finance and macroeconomics. We demonstrate that the risk premium and the risk‐free rate in these models are sensitive to ignoring heterogeneity. This follows because of endogenous withdrawal by nonexpected utility agents from the market for the risky asset. This finding is important precisely because these alternative preferences have frequently been proposed as possible resolutions to various asset pricing puzzles, and they have all been examined exclusively in a representative agent framework.