While the investors' responses to price changes and their price forecasts arewell accepted major factors contributing to large price fluctuations infinancial markets, our study shows that investors' heterogeneous and dynamicrisk aversion (DRA) preferences may play a more critical role in the dynamicsof asset price fluctuations. We propose and study a model of an artificialstock market consisting of heterogeneous agents with DRA, and we find that DRAis the main driving force for excess price fluctuations and the associatedvolatility clustering. We employ a popular power utility function,$U(c,\gamma)=\frac{c^{1-\gamma}-1}{1-\gamma}$ with agent specific andtime-dependent risk aversion index, $\gamma_i(t)$, and we derive an approximateformula for the demand function and aggregate price setting equation. Thedynamics of each agent's risk aversion index, $\gamma_i(t)$ (i=1,2,...,N), ismodeled by a bounded random walk with a constant variance $\delta^2$. We shownumerically that our model reproduces most of the ``stylized'' facts observedin the real data, suggesting that dynamic risk aversion is a key mechanism forthe emergence of these stylized facts.
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