Working Paper: NBER ID: w24641
Authors: Jerry Tsai; Jessica A. Wachter
Abstract: We solve for asset prices in a general affine representative-agent economy with isoelastic recursive utility and rare events. Our novel solution method is exact in two special cases: no preference for early resolution of uncertainty and elasticity of intertemporal substitution equal to one. Our results clarify model properties governed by the elasticity of intertemporal substitution, by risk aversion, and by the preference for early resolution of uncertainty. Finally, we show in a general setting that the linear relation between normal-times covariances and expected returns need not hold in a model with rare events.
Keywords: asset pricing; risk premia; recursive utility; rare events
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Elasticity of intertemporal substitution (EIS) (D15) | dynamics of the wealth-consumption ratio (E21) |
| preference for early resolution of uncertainty (D81) | risk premia (G22) |
| risk aversion = 1 (D81) | rare-event wealth CAPM (G19) |
| normal covariances and covariances during extreme events (C46) | expected returns on assets (G12) |