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Atlanta Fed Working Papers


Making the Case for a Low Intertemporal Elasticity of Substitution

R. Anton Braun and Tomoyuki Nakajima
Working Paper 2012-1
January 2012

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We provide two ways to reconcile small values of the intertemporal elasticity of substitution (IES) that range between 0.35 and 0.5 with empirical evidence that the IES is large. We do this reconciliation using a model in which all agents have identical preferences and the same access to asset markets. We also conduct an encompassing test, which indicates that specifications of the model with small values of the IES are more plausible than specifications with a large IES.

JEL classification: E21, E32, O41

Key words: uncertainty, intertemporal elasticity of substitution, risk aversion, business cycles, growth


The authors thank Francois Gourio, Fatih Guvenen, Chris Telmer, and Jaume Ventura for helpful discussions and Eric Aldrich for his assistance in writing some of the programs. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to R. Anton Braun, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8708, r.anton.braun@gmail.com, or Tomoyuki Nakajima, Institute of Economic Research, Kyoto University, Yoshida-Honmachi, Sakyo-ku, Kyoto 606-8501, 81-75-753-7102, nakajima@kier.kyoto-u.ac.jp.

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