Generalized Disappointment Aversion and Asset Prices




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    • Routledge is from the Tepper School of Business, Carnegie Mellon University. Zin is from The Stern School of Business, New York University and the NBER. The authors thank David Backus, Harjoat Bhamra, Gian Luca Clementi, Eddie Dekel, Larry Epstein, Richard Green, Lars Hansen, Campbell Harvey, Chew Soo Hong, Thomas Knox, Bart Lipman, Monika Piazzesi, Uday Rajan, Jacob Sagi, Robert Stambaugh (Editor), and an anonymous referee. They also thank seminar participants at the Bank of Portugal, Carnegie Mellon University, CEPR Gerzensee, CERGE Prague, the Cleveland Fed, HEC Montreal, Columbia University, IHS Vienna, NBER, Columbia University, New York University, Northwestern University, SED 2003, Simon Fraser University, University of British Columbia, University of Cincinnati, University of Houston, University of Washington, and WFA 2004, for helpful comments.


We characterize generalized disappointment aversion (GDA) risk preferences that can overweight lower-tail outcomes relative to expected utility. We show in an endowment economy that recursive utility with GDA risk preferences generates effective risk aversion that is countercyclical. This feature comes from endogenous variation in the probability of disappointment in the representative agent's intertemporal consumption-saving problem that underlies the asset pricing model. The variation in effective risk aversion produces a large equity premium and a risk-free rate that is procyclical and has low volatility in an economy with a simple autoregressive endowment-growth process.