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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.

Suggested Citation

  • Larry G. Epstein & Stanley E. Zin, 1987. "Substitution, Risk Aversion and the Temporal Behaviour of Consumption and Asset Returns II: An Empirical Analysis," Working Paper 698, Economics Department, Queen's University.
    • Handle: RePEc:qed:wpaper:698
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    Cited by:

    1. Cochrane, John H, 1989. "The Sensitivity of Tests of the Intertemporal Allocation of Consumption to Near-Rational Alternatives," American Economic Review, American Economic Association, vol. 79(3), pages 319-337, June.
    2. repec:hal:spmain:info:hdl:2441/8686 is not listed on IDEAS
    3. 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.
    4. 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.
    5. Samih Antoine Azar, 2018. "The Nexus Between the Elasticity of Intertemporal Substitution and the Coefficient of Relative Risk Aversion," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 9(3), pages 98-102, July.
    6. Guidolin, Massimo, 2006. "Pessimistic beliefs under rational learning: Quantitative implications for the equity premium puzzle," Journal of Economics and Business, Elsevier, vol. 58(2), pages 85-118.
    7. Attanasio, O.P. & Weber, G., 1989. "Consumption, Productivity Growth and the Interest Rate," Discussion Paper 1989-25, Tilburg University, Center for Economic Research.
    8. 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.
    9. Laurian Lungu & Patrick Minford, 2006. "Explaining The Equity Risk Premium," Manchester School, University of Manchester, vol. 74(6), pages 670-700, December.

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