The subjective discount factor and the coefficient of relative risk aversion under time-additive isoelastic expected utility model

TL;DR

This paper examines the relationship between the subjective discount factor and the coefficient of relative risk aversion within a standard asset pricing model, revealing that both cannot be high simultaneously for market equilibrium consistency.

Contribution

It provides theoretical insights into the restrictions on risk aversion and discounting factors necessary for equilibrium in asset markets.

Findings

High risk aversion and high discount factor cannot coexist for equilibrium

Constraints are derived to ensure market consistency with stylized facts

The model clarifies the interplay between risk preferences and time preferences

Abstract

By analysing the restrictions that ensure the existence of capital market equilibrium, we show that the coefficient of relative risk aversion and the subjective discount factor cannot be high simultaneously as they are supposed to be to make the standard asset pricing consistent with financial stylised facts.