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Preferences with Taste Shock Representations: Price Volatility and the Liquidity Premium

dc.contributor.author Krishna, RV
dc.contributor.author Sadowski, P
dc.date.accessioned 2016-12-07T15:41:49Z
dc.date.issued 2016-06-09
dc.identifier.uri https://hdl.handle.net/10161/13246
dc.description.abstract If price volatility is caused in some part by taste shocks, then it should be positively correlated with the liquidity premium. Our argument is based on Krishna and Sadowski (2014), who provide foundations for a representation of dynamic choice with taste shocks, and show that volatility in tastes corresponds to a desire to maintain flexibility. To formally connect volatile tastes to price volatility and preference for flexibility to the liquidity premium, we analyze a modified simple Lucas tree economy, where the representative agent is uncertain about his degree of future risk aversion, and where the productive asset cannot be traded in every period, while rights to output can. We show that a representative agent with a higher degree of uncertainty about his future risk aversion implies a higher liquidity premium (i.e., a lower price for the illiquid asset) and more price volatility.
dc.format.extent 13 pages
dc.publisher Elsevier BV
dc.relation.ispartof Economic Research Initiatives at Duke (ERID)
dc.title Preferences with Taste Shock Representations: Price Volatility and the Liquidity Premium
dc.type Journal article
duke.contributor.id Sadowski, P|0481304
pubs.issue 219
pubs.organisational-group Duke
pubs.organisational-group Economics
pubs.organisational-group Trinity College of Arts & Sciences


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