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Risk aversion, intertemporal substitution, and the aggregate investment-uncertainty relationship

  • Enrico Saltari
  • Davide Ticchi

We analyze the role of risk aversion and intertemporal substitution in a simple dynamic investment model. Our main finding is that risk aversion cannot by itself explain a negative relationship between aggregate investment and aggregate uncertainty, as the effect of increased uncertainty in investement also depends on the intertemporal elasticity of substitution. In particular, the relationship between aggregate investment and aggregate uncertainty is positive even if agents are very risk averse, as long as the elasticity of intertemporal substitution is low. A negative relationship requires thet the relative risk aversion and the elasticity of intertemporal substitution are both relatively high or both relatively low. We also show that the implications of our model are consistent with the available empirical evidence.

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Paper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 69.

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Length: 30
Date of creation: Feb 2002
Handle: RePEc:sap:wpaper:wp69
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