Recursive Utility and the Equity Premium Puzzle: A Discrete-Time Approach

32 Pages Posted: 9 Apr 2015 Last revised: 18 Sep 2015

See all articles by Knut K. Aase

Knut K. Aase

Norwegian School of Economics (NHH) - Department of Business and Management Science

Date Written: May 15, 2013

Abstract

We study the Epstein-Zin model with recursive utility. Recognizing that recursive preferences implies that the underlying model is not Markovian, we use methods not depending upon the Markov property to solve the model. We work with the returns directly, which we approximate by Taylor series expansions, in log terms. Leaving out moments of order three and higher, we calibrate the resulting model to the data of Mehra and Prescott (1985) under various assumptions about the wealth portfolio. The results are very reasonable for the US-data. We also calibrate to a newer Norwegian data set, where we also have the relevant estimates for the national wealth portfolio. Again, the results are consistent with plausible values for the preference parameters.

Keywords: Recursive utility, the Epstein-Zin model, utility gradients, calibrations, the Markov property

JEL Classification: G10, G12, D9, D51, D53, D90, E21

Suggested Citation

Aase, Knut K., Recursive Utility and the Equity Premium Puzzle: A Discrete-Time Approach (May 15, 2013). NHH Dept. of Business and Management Science Discussion Paper No. 2013/3. Available at SSRN: https://ssrn.com/abstract=2591808 or http://dx.doi.org/10.2139/ssrn.2591808

Knut K. Aase (Contact Author)

Norwegian School of Economics (NHH) - Department of Business and Management Science ( email )

Helleveien 30
Bergen, NO-5045
Norway

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