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Substitution, Risk Aversion and the Temporal Behaviour of Consumption and Asset Returns II: An Empirical Analysis

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  • Larry G. Epstein
  • Stanley E. Zin

Abstract

This paper investigates the testable restrictions on the time-series behaviour of consumption and asset returns implied by the consumption/portfolio choice problem of an infinitely-lived, representative agent. Intertemporal preferences are characterized by utility functions that generalize conventional, time-additive, expected utility. These generalizations of expected utility, allow for a clear separation of observable behaviour attributable to risk aversion and to intertemporal substitution, and also provide simple nested-tests of the expected utility hypothesis. Using monthly New York Stock Exchange returns data and consumption measured with either per capita expenditures on nondurables or nondurables and services, the expected utility model is rejected. The over-identifying restrictions implied by the non-expected utility model are tested and do not, in general, lead to rejections of the theory.

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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 698.

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Length: 54 pages
Date of creation: 1987
Date of revision:
Handle: RePEc:qed:wpaper:698

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Cited by:
  1. Aiyagari, S. Rao & Gertler, Mark, 1991. "Asset returns with transactions costs and uninsured individual risk," Journal of Monetary Economics, Elsevier, vol. 27(3), pages 311-331, June.
  2. Massimo Guidolin, 2005. "Pessimistic beliefs under rational learning: quantitative implications for the equity premium puzzle," Working Papers 2005-005, Federal Reserve Bank of St. Louis.
  3. 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.
  4. Laurian Lungu & Patrick Minford, 2006. "Explaining The Equity Risk Premium," Manchester School, University of Manchester, vol. 74(6), pages 670-700, December.
  5. Lettau, Martin & Uhlig, Harald, 1997. "Preferences, Consumption Smoothing, and Risk Premia," CEPR Discussion Papers 1678, C.E.P.R. Discussion Papers.

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