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Epstein–Zin Utility, Asset Prices, and the Business Cycle Revisited

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  • Christopher Heiberger
  • Halvor Ruf

Abstract

This paper discusses the advantages of Epstein and Zin (1989) (EZ) preferences when building dynamic stochastic general equilibrium (DSGE) models that are consistent with well‐known stylized facts of both the business cycle and asset markets. To this end, we combine EZ preferences with several building blocks from the DSGE literature that has tried to solve the equity premium puzzle and to replicate characteristic statistics of the labor market. Our goal is to guide researchers in this area to useful modeling devices and to discuss EZ preferences vis‐a‐vis the standard time‐additive expected utility function. EZ preferences separate the attitude toward risk from the attitude toward intertemporal substitution. We demonstrate that this additional degree of freedom allows us to closely match the empirical facts already in a frictionless production economy with endogenous labor supply. Our study follows Heer and Maußner (2013). We examine models that consider adjustment costs of capital accumulation, consumption habits, and frictions in the allocation of labor. Our empirical targets are estimated from German data.

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  • Christopher Heiberger & Halvor Ruf, 2019. "Epstein–Zin Utility, Asset Prices, and the Business Cycle Revisited," German Economic Review, Verein für Socialpolitik, vol. 20(4), pages 730-758, November.
    • Handle: RePEc:bla:germec:v:20:y:2019:i:4:p:e730-e758
    DOI: 10.1111/geer.12186
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    Cited by:

    1. Schön, Matthias & Stähler, Nikolai, 2020. "When old meets young? Germany's population ageing and the current account," Economic Modelling, Elsevier, vol. 89(C), pages 315-336.
    2. Johannes Huber & Christian Scharrer, 2024. "The fiscal and intergenerational burdens of brakes and subsidies for energy prices," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(5), pages 1249-1273, October.
    3. Asiye Aydilek & Harun Aydilek, 2020. "An optimization model of retiree decisions under recursive utility with housing," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 44(2), pages 258-277, April.
    4. Burkhard Heer & Alfred Maußner, 2024. "Dynamic General Equilibrium Modeling," Springer Texts in Business and Economics, Springer, edition 3, number 978-3-031-51681-8, December.
    5. Fehrle, Daniel & Heiberger, Christopher, 2024. "The return on everything and the business cycle in production economies," Economic Modelling, Elsevier, vol. 136(C).

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