Risk Aversion, Intertemporal Substitution and Consumption: the CARA-LQ Problem
AbstractThis paper employs the recursive utility approach, based on quadratic felicity functions and constant absolute risk aversion, to distinguish between risk aversion and intertemporal substitution. Stochastic dynamic programming yields closed-loop linear decision rules for the CARA-LQ problem. Certainty equivalence no longer holds, but instead the decision maker plays a min-max strategy against nature. When applied to a life cycle consumption problem, one finds a rationale for precautionary saving and a larger sensitivity of changes in consumption to income innovations. It is also shown that consumers with Ricardian rationality can display a Keynesian propensity to consume out of a current tax cut.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 359.
Date of creation: Jan 1990
Date of revision:
Contact details of provider:
Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
Other versions of this item:
- Van Der Ploeg, F., 1989. "Risk Aversion, Intertemporal Substitution And Consumption: The Cara-Lq Problem," Papers 8953, Tilburg - Center for Economic Research.
- Ploeg, F. van der, 1989. "Risk aversion, intertemporal substitution and consumption: The CARA-LQ problem," Discussion Paper 1989-53, Tilburg University, Center for Economic Research.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- David M Kreps & Evan L Porteus, 1978.
"Temporal Resolution of Uncertainty and Dynamic Choice Theory,"
Levine's Working Paper Archive
625018000000000009, David K. Levine.
- Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January.
- Philippe Weil, 1989.
"The Equity Premium Puzzle and the Riskfree Rate Puzzle,"
NBER Working Papers
2829, National Bureau of Economic Research, Inc.
- Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
- Phillippe Weil, 1997. "The Equity Premium Puzzle and the Risk-Free Rate Puzzle," Levine's Working Paper Archive 1833, David K. Levine.
- Kimball, Miles S. & Mankiw, N. Gregory, 1989.
"Precautionary Saving and the Timing of Taxes,"
3443105, Harvard University Department of Economics.
- Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October.
- Alberto Giovannini & Philippe Weil, 1989. "Risk Aversion and Intertemporal Substitution in the Capital Asset Pricing Model," NBER Working Papers 2824, National Bureau of Economic Research, Inc.
- Kreps, David M & Porteus, Evan L, 1979. "Dynamic Choice Theory and Dynamic Programming," Econometrica, Econometric Society, vol. 47(1), pages 91-100, January.
- Campbell, John & Deaton, Angus, 1989.
"Why Is Consumption So Smooth?,"
3221494, Harvard University Department of Economics.
- repec:fth:harver:1421 is not listed on IDEAS
- Sandmo, Agnar, 1970. "The Effect of Uncertainty on Saving Decisions," Review of Economic Studies, Wiley Blackwell, vol. 37(3), pages 353-60, July.
- Mark Huggett, 2004.
"Precautionary Wealth Accumulation,"
Review of Economic Studies,
Oxford University Press, vol. 71(3), pages 769-781.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.