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Intertemporal Substitutability, Risk Aversion and Asset Prices

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  • Dominique Pepin

    (CRIEF)

Abstract

Is the elasticity of intertemporal substitution (EIS) more or less than one? This question can be answered by confronting theoretical results of asset pricing models with investor behaviour during episodes of stock market panic. If we consider these episodes as periods of high risk aversion, then lower asset prices are in fact associated with higher risk aversion. However, according to theoretical models, risky asset price is an increasing function of the coefficient of risk aversion only if the EIS exceeds unity. It may therefore be concluded that the EIS must be more than one to reconcile theory with the observed stock price decline during periods of panic.

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  • Dominique Pepin, 2015. "Intertemporal Substitutability, Risk Aversion and Asset Prices," Papers 1505.07210, arXiv.org, revised Nov 2015.
    • Handle: RePEc:arx:papers:1505.07210
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    References listed on IDEAS

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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G0 - Financial Economics - - General

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