Download this Paper Open PDF in Browser

Do You Save More or Less in Response to Bad News? A New Identification of the Elasticity of Intertemporal Substitution

24 Pages Posted: 4 Jan 2015 Last revised: 4 May 2016

Lawrence D. W. Schmidt

University of Chicago - Department of Economics

Alexis Akira Toda

University of California, San Diego (UCSD) - Department of Economics

Date Written: May 3, 2016

Abstract

We define the elasticity of intertemporal substitution (EIS) for general recursive preferences and identify a sharp comparative static from a general dynamic portfolio choice problem. In the homothetic case, if the EIS is smaller (larger) than 1, an investor will increase (decrease) current consumption in response to bad news about the future. Examples of bad news include if (i) she becomes more risk averse, (ii) investment opportunities shrink, (iii) investment returns become riskier, or (iv) she becomes more uncertain about the distribution of returns. Bad news effectively raises the price of future continuation utility, which produces the same qualitative changes in savings rates as lowering the interest rate.

Keywords: elasticity of intertemporal substitution, optimal portfolio problem, recursive preferences

JEL Classification: D91, E21, G11

Suggested Citation

Schmidt, Lawrence D. W. and Toda, Alexis Akira, Do You Save More or Less in Response to Bad News? A New Identification of the Elasticity of Intertemporal Substitution (May 3, 2016). Available at SSRN: https://ssrn.com/abstract=2544688 or http://dx.doi.org/10.2139/ssrn.2544688

Lawrence D. W. Schmidt

University of Chicago - Department of Economics ( email )

1126 East 59th Street
Chicago, IL 60637
United States

HOME PAGE: http://https://sites.google.com/site/lawrencedwschmidt/home

Alexis Akira Toda (Contact Author)

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
Mail Code 0508
La Jolla, CA 92093-0508
United States

HOME PAGE: http://https://sites.google.com/site/aatoda111/

Paper statistics

Downloads
273
Rank
93,053
Abstract Views
1,000