Tuesday, 17 September 2013

The empirical relevance of imperfect risk sharing for asset pricing requires separation of Risk Aversion and Inter-temporal Substitution. The elasticity of the inter temporal substitution could be taken as reciprocal of the co-efficient of relative risk aversion given by gamma which has a close connection to market catastrophe. The stochastic discount factor is the inter temporal marginal rate of substitution. i.e. the discounted ratio of marginal utility in two successive periods. In the psychological models of decision making people make choices that differ in several respects from expected utility theory. In a static context it can be prospects where instead of preferences over consumption there are gains or losses relative to a benchmark outcome, with losses given greater weight. Gamma 's become curvature parameters and lambda,( from market wave) measures loss aversion.

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