Stanley E. Zin

Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework

This paper develops a class of recursive, but not necessarily expected utility, preferences over intertemporal consumption lotteries. An important feature of these general preferences is that they permit risk attitudes to be disentangled from the degree of intertemporal substitutability. Moreover, in an infinite horizon, representative-agent context, these preference specifications lead to a model of asset returns in which appropriate versions of both the atemporal CAPM and the intertemporal consumption CAPM are nested as special cases. In the authors general model, systematic risk of an asset is determined by covariance with both the return to the market portfolio and consumption growth. Copyright 1989 by The Econometric Society.

Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis

This paper investigates the testable restrictions on the time-series behavior of consumption and asset returns implied by a representative agent model in which intertemporal preferences are represented by utility functions that generalize conventional, time-additive, expected utility. The model based on these preferences allows a clearer separation of observable behavior attributable to risk aversion and to intertemporal substitution. Further, it nests the predictions of both the consumption CAPM and the static CAPM, and it allows direct tests of the expected utility hypothesis. We find that the performance of the non-expected utility model and tests of the expected utility hypothesis are sensitive to the choice of both consumption measure and instrumental variables.

'First-order' risk aversion and the equity premium puzzle

Abstract This paper integrates Yaaris dual theory of choice under uncertainty into a multiperiod context and examines its implications for the equity premium puzzle. An important property of these preferences is that of ‘first-order risk aversion’ which implies, in our model, that the risk premium for a small gamble is proportional to the standard deviation rather than the variance. Since the standard deviation of the growth rate in aggregate consumption is considerably larger than its variance, the model can generate both a small risk-free rate and a moderate equity premium.

Risk Premiums in the Term Structure: Evidence from Artificial Economies

We compare the stattstical properties of prices of US Treasury bills to those generated by a theoretical dynamic exchange economy wrth complete markets. We show that the model can account for netther the sign nor the magmtude of average risk premiums in forward prices and holding-period returns. The economy is also incapable of generating enough variation in risk premmms to account for reJections of the expectations hypotheses with Treasury bill data These conclusions add to the growing list of empiricat deficiencies of the representative agent model of asset pricmg

Long-Memory Inflation Uncertainty: Evidence from the Term Structure of Interest Rates

We use a fractional difference model to reconcile two features of yields on US government bonds with modem asset pricing theory: the persistence of the short rate and variability of the long end of the yield curve. We suggest that this process might arise from the response of the heterogeneous agents to the changes in monetary policy.

Exotic Preferences for Macroeconomists

We provide a users guide to exotic preferences: nonlinear time aggregators, departures from expected utility, preferences over time with known and unknown probabilities, risk-sensitive and robust control, hyperbolic discounting, and preferences over sets (temptations). We apply each to a number of classic problems in macroeconomics and finance, including consumption and saving, portfolio choice, asset pricing, and Pareto optimal allocations.

Spline Approximations To Value Functions

We review the properties of algorithms that characterize the solution of the Bellman equation of a stochastic dynamic program, as the solution to a linear program. The variables in this problem are the ordinates of the value function; hence, the number of variables grows with the state space. For situations in which this size becomes computationally burdensome, we suggest the use of low-dimensional cubic-spline approximations to the value function. We show that fitting this approximation through linear programming provides upper and lower bounds on the solution to the original large problem. The information contained in these bounds leads to inexpensive improvements in the accuracy of approximate solutions.

Sources of entropy in representative agent models

We propose two metrics for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The metrics describe the pricing kernels dispersion (the entropy of the title) and dynamics (time dependence, a measure of how entropy varies over different time horizons). We show how each model generates entropy and time dependence and compare their magnitudes to estimates derived from asset returns. This exercise -- and transparent loglinear approximations -- clarifies the mechanisms underlying these models. It also reveals, in some cases, tension between entropy, which should be large enough to account for observed excess returns, and time dependence, which should be small enough to account for mean yield spreads.

Monetary Policy and the Uncovered Interest Rate Parity Puzzle

High interest rate currencies tend to appreciate. This is the uncovered interest rate parity (UIP) puzzle. It is primarily a statement about short-term interest rates and how they are related to exchange rates. Short-term interest rates are strongly affected by monetary policy. The UIP puzzle, therefore, can be restated in terms of monetary policy. Do foreign and domestic monetary policies imply exchange rates that violate UIP? We represent monetary policy as foreign and domestic Taylor rules. Foreign and domestic pricing kernels determine the relationship between these Taylor rules and exchange rates. We examine different specifications for the Taylor rule and ask which can resolve the UIP puzzle. We find evidence in favor of a particular asymmetry. If the foreign Taylor rule responds to exchange rate variation but the domestic Taylor rule does not, the model performs better. A calibrated version of our model is consistent with many empirical observations on real and nominal exchange rates, including Famas negative correlation between interest rate differentials and currency depreciation rates.

Fractional Integration with Drift: Estimation in Small Samples

We examine the finite-sample behavior of estimators of the order of integration in a fractionally integrated time-series model. In particular, we compare exact time-domain likelihood estimation to frequency-domain approximate likelihood estimation. We show that over-differencing is of critical importance for time-domain maximum-likelihood estimation in finite samples. Overdifferencing moves the differencing parameter (in the over-differenced model) away from the boundary of the parameter space, while at the same time obviating the need to estimate the drift parameter. The two estimators that we compare are asymptotically equivalent. In small samples, however, the time-domain estimator has smaller mean squared error than the frequency-domain estimator. Although the frequency-domain estimator has larger bias than the time-domain estimator for some regions of the parameter bias, it can also have smaller bias. We use a simulation procedure which exploits the approximate linearity of the bias function to reduce the bias in the time-domain estimator.