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Tyler ABBOT (Sciences Po, Paris) – “Heterogeneous Risk Preferences in Financial Markets”

March 5, 3:30 pm - 4:30 pm

1st Monday of each month

Time: 3:30 pm – 4:30 pm
Date: 05th of March 2018
Place: Room 3105

Tyler ABBOT  (Sciences Po, Paris) – “Heterogeneous Risk Preferences in Financial Markets”


In this paper I build a continuous time model of a complete financial market with N heterogeneous agents whose constant relative risk aversion (CRRA) preferences differ in their level of risk aversion. I find that preference heterogeneity is able to replicate a high market price of risk and a low risk-free rate by separating the markets for risky and risk free assets. This provides an explanation for the equity risk premium and risk-free rate puzzles, while avoiding a preference for early resolution of uncertainty inherent in non-seperable preferences, i.e. Epstein-Zin preferences. Additionally, I find that changing the number of preference types has a non-trivial effect on the solution. Finally, I show through a numerical example that the model predicts several phenomena observed in financial data, namely a correlation between dividend yields and the stochastic discount factor, a non-linear response of volatility to shocks, and both pro- and counter-cyclical leverage cycles depending on the assumptions about the distribution of preferences.



March 5
3:30 pm - 4:30 pm
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