A Unified Theory of the Term Structure and the Beta Anomaly

Abstract

Rational expectation models generally suggest that assets with more exposure to systematic risks should carry higher risk premia. However, several empirical findings challenge this result. I propose a novel generalized recursive smooth aversion model that allows agents to show different levels of aversion to short-run consumption risk and long-run shocks. I apply this model to a consumption-based asset pricing model in which the representative agent’s consumption process is subject to rare but large disasters. The calibrated model matches major asset pricing moments, while riskier assets could carry lower risk premia.