The Importance of Timing Attitudes in Consumption-Based Asset Pricing Models
46 Pages Posted: 8 Dec 2016
Date Written: December 6, 2016
This paper introduces a new utility kernel for Epstein-Zin-Weil preferences to obtain greater flexibility in setting the intertemporal elasticity of substitution, the relative risk aversion (RRA), and the timing attitude compared to their standard implementation. We show that these new preferences resolve a puzzle in the long-run risk model, where consumption growth is too strongly correlated with the price-dividend ratio and the risk-free rate. The proposed preferences also resolve the puzzlingly high RRA in DSGE models, by enabling an otherwise standard New Keynesian model to match the equity premium and the bond premium with a low RRA of 5.
Keywords: Bond premium puzzle, Equity premium puzzle, Early Resolution of Uncertainty, Long-run risk
JEL Classification: E44, G12
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