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Agents' Preferences, the Equity Premium, and the Consumption-Saving Trade-Off

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  • Aude Pommeret
  • Anne Epaulard

Abstract

This paper aims to measure the risk premium on French equities during 1960-92 and to evaluate how well theoretical models based on various representations of agents'' preferences can explain it. Aside from the standard, time-additive utility function with constant relative risk aversion, three other utility functions are reviewed: a recursive utility function, a habit formation utility function, and a utility function that accounts for the interdependence of preferences. Both calibration and econometric estimations show that none of the studied marginal changes in the representation of agents'' preferences are sufficient to solve both the equity premium puzzle and the risk-free rate puzzle.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 01/117.

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Length: 36
Date of creation: 01 Aug 2001
Date of revision:
Handle: RePEc:imf:imfwpa:01/117

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References

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  1. David M Kreps & Evan L Porteus, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Levine's Working Paper Archive 625018000000000009, David K. Levine.
  2. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  3. Andrew B. Abel, 1990. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
  4. Lettau, Martin & Uhlig, Harald, 1997. "Preferences, Consumption Smoothing, and Risk Premia," CEPR Discussion Papers 1678, C.E.P.R. Discussion Papers.
  5. Summers, Lawrence H, 1991. " The Scientific Illusion in Empirical Macroeconomics," Scandinavian Journal of Economics, Wiley Blackwell, vol. 93(2), pages 129-48.
  6. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
  7. Gali, J., 1992. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice and Asset Prices," Papers 92-22, Columbia - Graduate School of Business.
  8. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
  9. Lund, Jesper & Engsted, Tom, 1996. "GMM and present value tests of the C-CAPM: evidence from the Danish, German, Swedish and UK stock markets," Journal of International Money and Finance, Elsevier, vol. 15(4), pages 497-521, August.
  10. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  11. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
  12. Philippe Jorion & William N. Goetzmann, 1999. "Global Stock Markets in the Twentieth Century," Journal of Finance, American Finance Association, vol. 54(3), pages 953-980, 06.
  13. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
  14. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  15. Lucas, Deborah J., 1994. "Asset pricing with undiversifiable income risk and short sales constraints: Deepening the equity premium puzzle," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 325-341, December.
  16. Koskievic, Jean-Max, 1999. "An intertemporal consumption-leisure model with non-expected utility," Economics Letters, Elsevier, vol. 64(3), pages 285-289, September.
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Cited by:
  1. Guy Meredith, 2001. "Why Has the Euro Been so Weak?," IMF Working Papers 01/155, International Monetary Fund.
  2. Epaulard, Anne & Pommeret, Aude, 2003. "Optimally eating a stochastic cake: a recursive utility approach," Resource and Energy Economics, Elsevier, vol. 25(2), pages 129-139, May.

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