Empirical evidence on the Euler equation for consumption in the US

Abstract

Recently developed econometric methods, that are robust to weak instruments and exploit information in possible structural changes, are applied to study the Euler equation for consumption using aggregate US post-war data. Several extensions to the baseline Euler equation model are investigated. The results are insensitive to using linear versus nonlinear specifications, different instruments or different consumption data, but they are very sensitive to asset returns. With risk-free returns, the elasticity of intertemporal substitution is tightly estimated around zero, while with stock market returns, it is significantly positive but very imprecisely estimated. There is no evidence of parameter instability.

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