Risk aversion, intertemporal substitution, and the aggregate investment-uncertainty relationship

We analyze the role of risk aversion and intertemporal substitution in a simple dynamic general equilibrium model of investment and savings. Our main finding is that risk aversion cannot by itself explain a negative relationship between aggregate investment and aggregate uncertainty, as the effect of increased uncertainty on investment also depends on the intertemporal elasticity of substitution. In particular, the relationship between aggregate investment and aggregate uncertainty is positive even if agents are very risk averse, as long as the elasticity of intertemporal substitution is low. A negative investment-uncertainty relationship requires that the relative risk aversion and the elasticity of intertemporal substitution are both relatively high or both relatively low. We also show that the implications of our model are consistent with the available empirical evidence

Local Durability and Long-Run Persistence: An Evaluation of the U.S. Risk Premia

I study the empirical properties of a non-linear stochastic dynamic representative-agent model with rational expectations. The representative agent is assumed to have time non separable preferences. The time nonseparability in preferences is due to local substitution of consumption over time as well as to long-run habit persistence. Specifically, I investigate whether the dynamic model replicates the observed mean and the standard deviation of the U.S real returns in the 1965-1987 period. I use a projection method to solve the model and then I evaluate the intertemporal marginal rate of substitution (IMRS) as well as the asset returns implied by the dynamic model. First, I find that the IMRS implied by the model statistically fits the Hansen and Jagannathan bound. Secondly, I find that combined effects of substituion and complementarity over consumption nearly solve the equity premium and the risk-free rate puzzles.

Calibration of normalised CES production functions in dynamic models

Normalising CES production functions in the calibration of basic dynamic models allows to choose technology parameters in an economically plausible way. When variations in the elasticity of substitution are considered, normalisation is necessary in order to exclude arbitrary effects. As an illustration, the effect of the elasticity of substitution on the speed of convergence in the Ramsey model is computed with different normalisations. --CES production functions,normalisation,calibration,Ramsey model

Local indeterminacy in two-sector overlapping generations models

In this paper, we consider a two-sector two-periods overlapping generations model with inelastic labor, consumption in both periods of life and homothetic CES preferences. We assume in a first step that the consumption levels are gross substitutes and the consumption good is capital intensive. We prove that when dynamic efficiency holds, the occurrence of sunspot fluctuations requires low enough values for the sectoral elasticities of capital-labor substitution. On the contrary, under dynamic inefficiency, local indeterminacy may be obtained without any restriction on the input substitutability properties. Assuming in a second step that gross substitutability in consumption does not hold, we show that sunspot fluctuations arise under dynamic efficiency without any restriction on the sign of the capital intensity difference across sectors and provided the sectoral elasticities of capital-labor substitution admit intermediary values.Two-sector OLG model, social production function, dynamic (in)efficiency, gross substitutability in consumption, local indeterminacy, sunspot fluctuations

Elasticity of Substitution between Capital and Labor and its applications to growth and development

This paper estimates the elasticity of substitution of an aggregate production function. The estimating equation is derived from the steady state of a neoclassical growth model. The data comes from the PWT in which different countries face different relative prices of the investment good and exhibit different investment-output ratios. Then, taking advantage of this variation we estimate the long-run elasticity of substitution. Using various estimation techniques, we find that the elasticity of substitution is 0.7, which is lower than the elasticity, 1, that is traditionally used in macro-development exercises. We show that this lower elasticity reinforces the power of the neoclassical model to explain income differences across countries as coming from differential distortions.Demand for Investment, Dynamic Panel Data, Elasticity of Substitution

Intertemporal substitution and recursive smooth ambiguity preferences

In this paper, we establish an axiomatically founded generalized recursive smooth ambiguity model that allows for a separation among intertemporal substitution, risk aversion, and ambiguity aversion. We axiomatize this model using two approaches: the second-order act approach à la Klibanoff, Marinacci, and Mukerji (2005) and the two-stage randomization approach à la Seo (2009). We characterize risk attitude and ambiguity attitude within these two approaches. We then discuss our model's application in asset pricing. Our recursive preference model nests some popular models in the literature as special cases.Ambiguity, ambiguity aversion, risk aversion, intertemporal substitution, model uncertainty, recursive utility, dynamic consistency

On the Trade Balance Response to Monetary Shocks: the Marshall-Lerner Conditions Reconsidered

This paper studies the applicability of the Marshall-Lerner condition to the "basic" Obstfeld and Rogoff (1995) model. It shows that the Marshall-Lerner condition does apply to this class of models with homothetic preferences when product differentiation across countries is imposed. This paper also shows that, in certain cases, the intertemporal substitution and the dynamic income effect can make the mere elasticity of substitution an insufficient indicator of the response of the current account to monetary shocks.Trade Balance, Marshall-Lerner Conditions, Elasticity of Substitution, Monetary Shocks, Transfer Problem

Does the growth of mobile markets cause the demise of fixed networks? Evidence from the European Union

The increasing usage of mobile communication and the declining demand for fixed line telephony in Europe make the analysis of substitutional effects between fixed and mobile networks a key aspect for future telecommunication regulation. Using a unique dataset which contains information on all 27 European Union members from 2003 to 2009, we analyze substitutability between fixed and mobile telecommunications services in Europe by applying dynamic panel data techniques. We find strong empirical evidence for substitution from fixed to cellular networks throughout Europe. In addition, the article reveals resulting policy implications. --dynamic panel model,fixed-mobile substitution,telecommunication markets

Economic determinants of global mobile telephony growth

This study examines the substitution effect between fixed-line and mobile telephony while controlling for the consumption externality associated with telephone networks. A dynamic demand model is estimated using a global telecommunications panel dataset comprised of 56 countries from 1995–2000. Estimation results show the presence of a substantial substitution effect. Additionally income and own-price elasticities are reported. Analysis of impulse responses for price, income and network size indicate substantial mobile telephone growth is yet to be realised. However, price ceilings imposed in the fixed-line network can retard the growth of the mobile network.

On natural resource substitution

We present a simple dynamic model to get some key insights about the substitution of renewable for nonrenewable resources in production and the consequences for sustainability. We highlight the role of the elasticity of substitution (technological component) to determine the adjustment of every sector as a response to scarcity and growing ability of resources (environmental component). Sometimes, the model predicts a smooth substitution of renewable resources for nonrenewables, but this process could work in the opposite direction if renewable resources are temporarily beyond their maximum sustainable yield, so that their marginal natural growth is negative. If substitution possibilities are high enough, it may be optimal to suspend the extraction of a resource, for example, to allow for regeneration of the biomass. We show analytically that a production process is more likely to be sustainable the more heavily it depends on renewable, rather than nonrenewable resources.Renewable resources, Nonrenewable resources, Production, Optimal control.