Working Paper: NBER ID: w2824
Authors: Alberto Ciovannini; Philippe Weil
Abstract: When tastes are represented by a class of generalized preferences which -- unlike traditional Von-Neumann preferences -- do not confuse behavior towards risk with attitudes towards intertemporal substitution, the true beta of an asset is, in general, an average of its consumption and market betas. We show that the two parameters measuring risk aversion and intertemporal substitution affect consumption and portfolio allocation decisions in symmetrical ways. A unit elasticity of intertemporal substitution gives rise to myopia in consumption-savings decisions (the future does not affect the optimal consumption plan), while a unit coefficient of relative risk aversion gives rise to myopia in portfolio allocation (the future does not affect optimal portfolio allocation). The empirical evidence is consistent with the behavior of intertemporal maximizers who have a unit coefficient of relative risk aversion and an elasticity of intertemporal substitution different from 1.
Keywords: Risk Aversion; Intertemporal Substitution; Capital Asset Pricing Model
JEL Codes: G12; D81
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unit elasticity of intertemporal substitution (D15) | myopia in consumption-savings decisions (D15) |
| unit coefficient of relative risk aversion (D11) | myopia in portfolio allocation (G11) |
| risk aversion and intertemporal substitution (D15) | asset pricing and consumption choices (D15) |