Essays on asset pricing with generalized preferences
This dissertation consists of two essays on asset pricing with generalized preferences. The first chapter investigates a model in which utility is defined over consumption relative to habit, which consists of a weighted sum of past individual and societal consumption. This class of preferences is motivated by Abel (1990), and includes both "catching up with the Joneses" and pure "ratio style" habit formation (with utility defined over consumption growth) as special cases. This model is able to generate a large equity premium, but also produces an excessively volatile riskfree rate. The second chapter introduces a preference functional which is quadratic in the probabilities. This preference functional incorporates the first two moments of the utility function and provides a natural, parsimonious and tractable generalization of expected utility. Economically, the quadratic preference functional extends expected utility by introducing the notion of aversion to utility risk (as opposed to payoff risk). Moreover, it disentangles decreasing marginal utility from risk aversion. In a dynamic setting, this produces a "wedge" between intertemporal substitution and risk aversion. This model is able to generate a large equity premium without producing an excessively volatile riskfree rate.
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