Download This PaperConsumption Smoothing and the Equity Premium
30 Pages Posted: 14 Nov 2010
Date Written: November 12, 2010
Abstract
The paper investigates the role of the Intertemporal Elasticity of Substitution (IES ) in determining the equity premium. This is done in an overlapping generations economy populated by agents that live for 2 periods and maximize a Kihlstrom-Mirman expected utility function. The equity premium depends both on the demand for smoothing as measured by the inverse of IES and on risk aversion but the first seems to play a more important role. The paper also attempts to understand the difference between the predictions of a 2 periods Kihlstrom-Mirman expected utility and the predictions of a 2 periods Epstein-Zin-Weil utility.
Keywords: Fluctuations Aversion, Risk Aversion, Asset Prices, Equity Premium Puzzle, Risk Free Rate Puzzle
JEL Classification: D11, D81, D91, G12
Suggested Citation: Suggested Citation
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