An Estimation of Economic Models with Recursive Preferences

56 Pages Posted: 14 Mar 2008

See all articles by Xiaohong Chen

Xiaohong Chen

Yale University - Cowles Foundation

Jack Y Favilukis

University of British Columbia (UBC) - Division of Finance

Sydney C. Ludvigson

New York University - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: March, 11 2008

Abstract

This paper presents estimates of key preference parameters of the Epstein and Zin (1989, 1991) and Weil (1989) (EZW) recursive utility model, evaluates the model's ability to fit asset return data relative to other asset pricing models, and investigates the implication of such estimates for the unobservable aggregate wealth return. Our empirical results indicate that the estimated relative risk aversion parameter is high, ranging from 17-60, with higher values for aggregate consumption than for stockholder consumption, while the estimated elasticity of intertemporal substitution is above one. In addition, the estimated model-implied aggregate wealth return is found to be weakly correlated with the CRSP value-weighted stock market return, suggesting that the return to human wealth is negatively correlated with the aggregate stock market return. In quarterly data from 1952 to 2005, we find that an SMD estimated EZW recursive utility model can explain a cross-section of size and book-market sorted portfolio equity returns better than the standard consumption-based model based on power utility and about as well as the Lettau and Ludvigson (2001b) cay-scaled consumption CAPM model, but not as well as models based on financial factors such as the Fama and French (1993) three-factor model.

Suggested Citation

Chen, Xiaohong and Favilukis, Jack Y and Ludvigson, Sydney C., An Estimation of Economic Models with Recursive Preferences (March, 11 2008). Available at SSRN: https://ssrn.com/abstract=1105136 or http://dx.doi.org/10.2139/ssrn.1105136

Xiaohong Chen

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States

Jack Y Favilukis (Contact Author)

University of British Columbia (UBC) - Division of Finance ( email )

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Vancouver, BC V6T 1Z2
Canada

Sydney C. Ludvigson

New York University - Department of Economics ( email )

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New York, NY 10012
United States
212-998-8927 (Phone)
212-995-4186 (Fax)

HOME PAGE: http://www.econ.nyu.edu/user/ludvigsons/

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