Risk and Return in Village Economies
We present a model for the study of risk and return of household assets in village economies. The model yields similar insights and predictions to those derived from the traditional Capital Asset Pricing Model (CAPM) and the Consumption based Asset Pricing Model (CCAPM) in finance literature. We apply our model to the monthly panel data from a household survey in rural Thailand. First, we find that higher exposure to aggregate, non-diversifiable risks, as measured by household beta, or the co-movement of individual returns with the aggregate, is related to higher expected return on household assets. This finding is consistent with a major prediction from our model. The result is robust when we extend our definition of the aggregate economy or the market from village to province, and to the entire sample, or focus our definition to kinship networks within a village. The result is also robust when we control for household demography, asset sizes, and household occupations. We then use the prediction from the model to compute the risk-adjusted return for each household, i.e. the household alpha in CAPM terminology. Finally, we apply our model to the study of the village equity premium and estimate the implied coefficient of relative risk aversion. In contrast to “the equity premium puzzle” in the finance literature, our data at the less aggregate levels deliver estimates with a reasonably low magnitude. We also find that the larger the definition of the market, the more unreasonable magnitude of the implied risk aversion coefficient.
Presented at the CFSP & MFI 2009 Finance and Development Conference.