Risk Aversion and the Labor Margin in Dynamic Equilibrium Models
American Economic Review · 2012 · Volume 102 · Issue 4
Abstract
The household's labor margin has a substantial effect on risk aversion, and hence asset prices, in dynamic equilibrium models even when utility is additively separable between consumption and labor. This paper derives simple, closed-form expressions for risk aversion that take into account the household's labor margin. Ignoring this margin can dramatically overstate the household's true aversion to risk. Risk premia on assets priced with the stochastic discount factor increase essentially linearly with risk aversion, so measuring risk aversion correctly is crucial for asset pricing in the model.
Keywords
Consumer Economics: Theory, Criteria for Decision-Making under Risk and Uncertainty, Asset Pricing, Trading volume, Bond Interest Rates, Time Allocation and Labor Supply, One, Two, and Multisector Growth Models
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