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

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.

Zhiting Wu
Zhiting Wu
PhD Candidate in Economics and Finance

My research interests include Asset Pricing, Macro-Finance, and Macroeconomics.