The Nexus Between the Elasticity of Intertemporal Substitution and the Coefficient of Relative Risk Aversion

Abstract

One advantage of the Epstein-Zin preference function is that it disentangles the elasticity of intertemporal substitution (EIS) from the coefficient of relative risk aversion (CRRA). The paper subjects this preference function to statistical analysis. The methodology is to calculate the unconditional average of this new Euler equation and to find out if such an average is statistically insignificantly different from zero. Seventeen individual and different stocks are used. The results show that, when the EIS is fixed, the CRRA has multiple solutions. In some cases there are three solutions and not only two. Moreover these solutions extend to wide ranges.