What Drives Stochastic Risk Aversion

I examine determinants of stochastic relative risk aversion in conditional asset pricing models. I first develop time-series specification tests with nonlinear state-space models with heteroskedasticity based on Merton (1973)'s ICAPM. I then established the following facts. First, the surplus consumption ratio implied by the external habit formation model is the most important determinant of relative risk aversion. Second, the CAY of Lettau and Ludvigson (2001a) without a look-ahead bias explains part of relative risk aversion, and the short term interest rate has some explanatory power for hedging components....