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Heterogenous intertemporal elasticity of substitution and relative risk aversion: estimation of optimal consumption choice with habit formation and measurement errors

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  • Natalia, Khorunzhina
  • Wayne Roy, Gayle

Abstract

This paper investigates the existence and degree of variation across house holds and over time in the intertemporal elasticity of substitution (IES) and the coefficient of relative risk aversion (RRA) that is generated by habit forming preferences. To do so, we develop a new nonlinear GMM estimator to investigate the presence of habit formation in household consumption using data from the Panel Study of Income Dynamics. Our method accounts for classical measurement errors in consumption without parametric assumptions on the distribution of measurement errors. The estimation results support habit formation in food consumption. Using these estimates, we develop bounds for the expectation of the implied heterogenous intertemporal elasticity of substitution and relative risk aversion that account for measurement errors and compute asymptotically valid confidence intervals on these bounds. We find that these parameters display significant variation across households and over time.

Suggested Citation

  • Natalia, Khorunzhina & Wayne Roy, Gayle, 2011. "Heterogenous intertemporal elasticity of substitution and relative risk aversion: estimation of optimal consumption choice with habit formation and measurement errors," MPRA Paper 34329, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:34329
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    References listed on IDEAS

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    More about this item

    Keywords

    Nonlinear models; Classical measurement errors; Habit formation; Intertemporal elasticity of substitution; Relative risk aversion;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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