Non-Separable Preferences, Stochastic Returns and Intertemporal Substitution in Consumption
115 Pages Posted: 7 Aug 2014
Date Written: April 10, 1986
Fischer Black provided a summary of my 1986 Princeton thesis. The idea in my thesis predates Epstein-Zin (1989). Black wrote:
"Greenig (1986) explores time-nonseparable utility as a way of separating risk tolerance from elasticity of intertemporal substitution, and as a way of explaining things like the 'equity premium puzzle.' He introduces exactly the utility function that I favor for capturing consumption smoothing (p. 30). In his model, local utility depends on a weighted geometric average of current and past levels of consumption … This is not the most general utility function, but it is general enough, I think, to eliminate the 'equity premium puzzle' as described by Mehra and Prescott (1985) and the 'real interest rate puzzle' as described by Weil (1989). In other words, it is general enough to explain why the consumption series is smoother than the wealth series at market value." From Black, Exploring General Equilibrium, 1995 (pp. 22 and 184-185).
Keywords: Equity premium puzzle, Time-nonseparable utility, Elasticity of substitution, Consumption smoothing, Real interest rate puzzle, Epstein-Zin.
JEL Classification: G12, E21, E32
Suggested Citation: Suggested Citation