BibTeX
@MISC{Liu_estimatingthe,
author = {Fang Liu and Piet Sercu and Lieven Demoor},
title = {Estimating the Intertemporal Substitution Elasticity},
year = {}
}
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Abstract
Lyrio and Kristien Smedts—for very useful criticisms. Also comments from Katelijne Carbonez, Van Nguyen, and Armien Schwienbacher were very helpful, and from participants at presentations in Vienna (WU), Brussels (KULeuven/UCLouvain). Any remaining errors are the authors ’ responsability. To estimate the elasticity of intertemporal substitution (eis), one traditionally assumed time-additive utility and constant relative risk aversion, but that model is often regarded as a failure as little or no link is detected between expected real consumption growth and the real interest rate. We test whether the inverse of the eis is really all that different from the rra estimates we get from eg equity markets, ie, whether time-additive utility is really such a bad assumption. We find that by simple modifications of the basic model—namely, accounting for seasonals and allowing for effects stemming from changes in wealth—produces elasticities that are quite compatible with other studies, including values implied by the more reasonable range of risk-aversion estimates obtained from capm tests. Our eis estimates are obtained from gmm, after unsuccessfully trying the standard proxy for expected inflation. We also pool data from 24 countries, as single-country estimates are very imprecise and erratic. Our attempt to reduce the time-aggregation problem in consumption data, lastly, is successful in the sense that the resulting eis estimates are even higher.
Keyphrases
intertemporal substitution elasticity time-additive utility eis estimate real consumption growth eg equity market remaining error bad assumption van nguyen standard proxy risk-aversion estimate reasonable range basic model kristien smedts consumption data constant relative risk aversion simple modification real interest rate capm test intertemporal substitution katelijne carbonez wealth produce elasticity kuleuven uclouvain armien schwienbacher time-aggregation problem single-country estimate author responsability useful criticism
