The Relative Risk Aversion (RRA) Riddle

Purpose: Looking for a way to solve the risk aversion puzzle, this article develops a model that incorporates loss aversion into the state dependent recursive preferences.Design/Methodology/Approach: In this model, the representative agent is restricted to be risk averse in all states of nature.In addition, I calibrate the model in selected developed countries.Findings: The model succeeds in generating a relative risk aversion value below ten, but the generated stochastic discount factor fails in matching its implied values.Moreover, a representative agent who has the S-shaped loss averse preferences could not solve the model either.Practical implications: Hence, it reveals another distinctive risk aversion riddle.Originality value: A low risk aversion value is not the answer to the equity premium puzzle.Nevertheless, studying the effect of loss aversion on recursive preferences gives delightful insights and better understanding of many details to the problem in hand.