Disentangling the Coefficient of Relative Risk Aversion from the Elasticity of Intertemporal Substitution: An Irrelevance Result

Abstract

ABSTRACT For homothetic time and state separable preferences, the coefficient of relative risk aversion (CRRA) is equal to the reciprocal of the elasticity of intertemporal substitution (EIS). This paper shows that, when the growth rate of consumption is i.i.d., asset pricing models based upon preferences in which the CRRA and the EIS are no longer linked do not have more explanatory power. Further, in these stochastic environments, estimates of the CRRA in the standard preferences are measures of the true CRRA and not the EIS. These results are fairly accurate descriptions of economies calibrated using United States annual data.