The Sensitivity of Risk Premiums to the Elasticity of Inter-Temporal Substitution

54 Pages Posted: 9 Feb 2021

See all articles by Zhiting Wu

Zhiting Wu

School of Economics and Finance, University of St Andrews

Date Written: February 6, 2021

Abstract

I incorporate the recursive utility into Pagel (2016)'s reference-dependent preference and study their aggregate implications in a consumption-based asset pricing model. In the case of recursive utility, the proposed model reproduces crucial asset pricing moments and time-varying risk premiums with a simple IID process for consumption growth. Second, the proposed model consistently predicts that the agent prefers a late resolution of uncertainty in both time-separable and recursive utility. My additional finding is that intertemporal substitution elasticity is more sensitive to asset prices given the recursive preference. Finally, the introduction of sluggish-updating can improve model performances.

Keywords: Loss Aversion, Recursive Utility, Time Resolution of Uncertainty, Consumption-Based Asset Pricing

JEL Classification: E22, E3, G1

Suggested Citation

Wu, Zhiting, The Sensitivity of Risk Premiums to the Elasticity of Inter-Temporal Substitution (February 6, 2021). Available at SSRN: https://ssrn.com/abstract=3780403 or http://dx.doi.org/10.2139/ssrn.3780403

Zhiting Wu (Contact Author)

School of Economics and Finance, University of St Andrews ( email )

Castle Cliff
St Andrews
St Andrews, KY16 9AR
United Kingdom

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