Articlediamond2013

An estimation of economic models with recursive preferences

Xiaohong Chen · Jack Favilukis · Sydney C. Ludvigson

90 citations0/0 files storedQuantitative Economics

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Financial Markets and Investment Strategies Stochastic processes and financial applications Economic theories and models

Abstract

This paper presents estimates of key preference parameters of the Epstein and Zin (1989, 1991) and Weil (1989) recursive utility model, evaluates the model's ability to fit asset return data relative to other asset pricing models, and investigates the implications of such estimates for the unobservable aggregate wealth return. Our empirical results indicate that the estimated relative risk aversion parameter ranges from 17 to 60, with higher values for aggregate consumption than for stockholder consumption, while the estimated elasticity of intertemporal substitution is above 1. In addition, the estimated model-implied aggregate wealth return is found to be weakly correlated with the Center for Research in Security Prices value-weighted stock market return, suggesting that the return to human wealth is negatively correlated with the aggregate stock market return.

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References

1993Common risk factors in the returns on stocks and bonds 1992The Cross-Section of Expected Stock Returns 1996Multifactor Explanations of Asset Pricing Anomalies 1989Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework 2000Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles 2001Consumption, Aggregate Wealth, and Expected Stock Returns 1990A VARIANCE DECOMPOSITION FOR STOCK RETURNS 2013Handbook of the Economics of Finance

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