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American Economic Review: Vol. 102 No. 4 (June 2012)

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Risk Aversion and the Labor Margin in Dynamic Equilibrium Models

Article Citation

Swanson, Eric T. 2012. "Risk Aversion and the Labor Margin in Dynamic Equilibrium Models." American Economic Review, 102(4): 1663-91.

DOI: 10.1257/aer.102.4.1663

Abstract

The household's labor margin has a substantial effect on risk aversion, and hence asset prices, in dynamic equilibrium models even when utility is additively separable between consumption and labor. This paper derives simple, closed-form expressions for risk aversion that take into account the household's labor margin. Ignoring this margin can dramatically overstate the household's true aversion to risk. Risk premia on assets priced with the stochastic discount factor increase essentially linearly with risk aversion, so measuring risk aversion correctly is crucial for asset pricing in the model.

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Authors

Swanson, Eric T. (Federal Reserve Bank of San Francisco)

JEL Classifications

D11: Consumer Economics: Theory
D81: Criteria for Decision-Making under Risk and Uncertainty
G12: Asset Pricing; Trading volume; Bond Interest Rates
J22: Time Allocation and Labor Supply
O41: One, Two, and Multisector Growth Models


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