Multivariate risk aversion and intertemporal substitution

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Abstract

Researchers often assume that preferences over uncertain consumption streams are representable by {Mathematical expression}, where {Mathematical expression}, is (random) period t consumption. It is moreover often asserted that estimates of γ cannot be unambiguously interpreted, since the quantity 1 - γ measures both relative risk aversion and the reciprocal of the elasticity of substitution. Clearly, this ambiguity arises only if 1 - γ indeed measures risk aversion. Although changes in γ cannot reflect changes in risk aversion according to standard definitions of comparative multivariate risk aversion, we show that γ is rationalizable as a risk aversion measure provided that the "acceptance set" of sure prospects is restricted. We also show, however, that there is essentially no relationship between changes in γ and optimal consumption, even in a simple two period model; this finding casts doubt upon the interpretation of γ as a risk aversion measure.

Original languageEnglish (US)
Pages (from-to)159-169
Number of pages11
JournalThe GENEVA Papers on Risk and Insurance Theory
Volume17
Issue number2
DOIs
StatePublished - Dec 1992

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Keywords

  • Intertemporal Substitution
  • Multivariate Risk Aversion

ASJC Scopus subject areas

  • Accounting
  • Business, Management and Accounting(all)
  • Finance
  • Economics and Econometrics

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