Estimating the elasticity of intertemporal substitution accounting for stockholder-specific portfolios

ABSTRACT

This article estimates the elasticity of intertemporal substitution using stockholder actual return experience. The approach is motivated by numerous data sources indicating that the median US stockholder has a portfolio composed of only three or four individual stocks, rather than a well-diversified portfolio as suggested by portfolio theory. Therefore, representing an individual stockholder portfolio by a proxy financial index (the common approach taken in the literature) may be too rough an approximation of investor behaviour and lead to biased results about risk aversion and intertemporal substitution. Eschewing the financial index methodology, our results support the standard representative agent assumption that there is a high degree of homogeneity in the elasticity of intertemporal substitution across stockholders with different wealth levels. Our findings have implications for models that assess the comovement between consumption and return on stocks.

KEYWORDS:

• Asset pricing
• portfolio choice
• heterogeneous agents
• and risk aversion

JEL CLASSIFICATION:

• G10
• G11
• G12

Acknowledgement

We thank seminar participants at the Both Graduate School, Chicago University, University of British Columbia at Okanagan, University of New Hampshire, and Robert School of Finance and Economics.

Disclosure statement

No potential conflict of interest was reported by the authors.