Estimating the Elasticity of Intertemporal Substitution Using Mortgage Notches

81 Pages Posted: 21 Aug 2018

See all articles by Michael Best

Michael Best

Columbia University

James Cloyne

University of California, Davis; Bank of England - Monetary Analysis

Ethan Ilzetzki

London School of Economics & Political Science (LSE) - Department of Economics

Henrik Kleven

Princeton University - Woodrow Wilson School of Public and International Affairs

Multiple version iconThere are 2 versions of this paper

Date Written: August 2018

Abstract

Using a novel source of quasi-experimental variation in interest rates, we develop a new approach to estimating the Elasticity of Intertemporal Substitution (EIS). In the UK, the mortgage interest rate features discrete jumps -- notches -- at thresholds for the loan-to-value (LTV) ratio. These notches generate large bunching below the critical LTV thresholds and missing mass above them. We develop a dynamic model that links these empirical moments to the underlying structural EIS. The average EIS is small, around 0.1, and quite homogeneous in the population. This finding is robust to structural assumptions and can allow for uncertainty, a wide range of risk preferences, portfolio reallocation, liquidity constraints, present bias, and optimization frictions. Our findings have implications for the numerous calibration studies that rely on larger values of the EIS.

JEL Classification: D14, E21, E43, H31

Suggested Citation

Best, Michael and Cloyne, James and Ilzetzki, Ethan and Kleven, Henrik, Estimating the Elasticity of Intertemporal Substitution Using Mortgage Notches (August 2018). CEPR Discussion Paper No. DP13104. Available at SSRN: https://ssrn.com/abstract=3235587

Michael Best (Contact Author)

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

James Cloyne

University of California, Davis ( email )

One Shields Avenue
Davis, CA 95616
United States

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

Ethan Ilzetzki

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Henrik Kleven

Princeton University - Woodrow Wilson School of Public and International Affairs ( email )

Princeton University
Princeton, NJ 08544-1021
United States

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