Evaluating risky consumption paths: The role of intertemporal substitutability
AbstractIn dynamic stochastic welfare comparisons, a failure clearly to distinguish between risk aversion and intertemporal substitutability can result in misleading assessments of the impact of risk aversion on the welfare costs of consumption-risk changes. The problem arises in any setting in which uncertainty is propagated over time, notably, but not exclusively, in economies with stochastic consumption trends. Regardless of the preference setup adopted, an increase in risk aversion amplifies the per-period costs of risks. The weights consumers use to cumulate the per-period costs of risks with persistent effects should, however, depend on intertemporal substitutability as well as on risk aversion. Under time-separable expected-utility preferences, an increase in the period utility function's curvature therefore alters the welfare effect of risk for reasons that in part are unrelated to risk aversion.
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Bibliographic InfoArticle provided by Elsevier in its journal European Economic Review.
Volume (Year): 38 (1994)
Issue (Month): 7 (August)
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Web page: http://www.elsevier.com/locate/eer
Other versions of this item:
- Maurice Obstfeld, 1995. "Evaluating Risky Consumption Paths: The Role of Intertemporal Substitutability," NBER Technical Working Papers 0120, National Bureau of Economic Research, Inc.
- E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
- D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
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