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- Title
The sensitivity of risk premiums to the elasticity of intertemporal substitution.
- Authors
Wu, Zhiting
- Abstract
This paper incorporates reference‐dependent preferences into a consumption‐based asset pricing model featuring Epstein–Zin utility. Three relevant results emerge from this extension. First, agents prefer the late resolution of uncertainty in recursive utility. Second, the late resolution of uncertainty helps replicate the downward‐sloping term structure of market excess return. Third, the intertemporal substitution elasticity is more sensitive to asset prices through increasing precautionary saving motivations. A closed‐form solution for the proposed model largely explains (i) high, volatile, and countercyclical equity premiums; (ii) low risk‐free rates; and (iii) the downward‐sloping term structure of equity premiums and variance ratios.
- Subjects
ELASTICITY (Economics); ABNORMAL returns; RISK premiums; MARKET design &; structure (Economics); PRICE increases; PRICES
- Publication
Financial Management (Wiley-Blackwell), 2024, Vol 53, Issue 2, p353
- ISSN
0046-3892
- Publication type
Article
- DOI
10.1111/fima.12447