Implied Risk Aversion in Lottery Bond Prices♦

Both the equity premium puzzle and the credit spread puzzle address the problem of a reasonable size of agents’ risk aversion. The empirical estimation of risk aversion parameters is impeded by the fact that observed prices depend on risk preferences and probability beliefs. The market for German redemption lottery bonds constitutes a clean environment to estimate risk aversion coefficients from transaction prices as the probabilities of price changes caused by redemption lotteries are objectively known. We contribute to the literature by estimating implied relative risk aversion coefficients from bond market data within a fully specified dynamic equilibrium model. Our most important findings are threefold: estimated relative risk aversion coefficients are significantly positive, of moderate magnitude, and not significantly different across issuer groups. JEL Classificaton: G12, G32, G31, G11