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An estimation of economic models with recursive preferences

Chen, Xiaohong and Favilukis, Jack and Ludvigson, Sydney C. (2007) An estimation of economic models with recursive preferences. Discussion paper, 603. Financial Markets Group, London School of Economics and Political Science, London, UK.

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Identification Number: 603

Abstract

This paper presents estimates of key preference parameters of the Epstein and Zin (1989, 1991) and Weil (1989) (EZW) recursive utility model, evaluates the model’s ability to fit asset return data relative to other asset pricing models, and investigates the implications of such estimates for the unobservable aggregate wealth return. Our empirical results indicate that the estimated relative risk aversion parameter is high, ranging from 17-60, with higher values for aggregate consumption than for stockholder consumption, while the estimated elasticity of intertemporal substitution is above one. In addition, the estimated model-implied aggregate wealth return is found to be weakly correlated with the CRSP value-weighted stock market return, suggesting that the return to human wealth is negatively correlated with the aggregate stock market return. In quarterly data from 1952 to 2005, we find that an SMD estimated EZW recursive utility model can explain a cross-section of size and book-market sorted portfolio equity returns better than the standard consumption-based model based on power utility and better than the Lettau and Ludvigson (2001b) cay-scaled consumption CAPM model, but not as well as the Fama and French (1993) three-factor model with financial returns as risk factors.

Item Type: Monograph (Discussion Paper)
Official URL: http://fmg.lse.ac.uk
Additional Information: © 2007 The Authors
Subjects: H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Collections > LSE Financial Markets Group (FMG) Working Papers
Date Deposited: 16 Jul 2009 14:54
Last Modified: 27 Feb 2014 15:35
URI: http://eprints.lse.ac.uk/id/eprint/24502

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