Intertemporal Elasticity of Substitution and Risk Aversion: Are They Related Empirically?

This paper examines the relationship between two types of preference: preference of intertemporal choices and preference towards risk. In the simplest form of the constant relative risk aversion utility function, the intertemporal elasticity of substitution (IES) and risk aversion has an inverse relationship. However, there is no empirical evidence that suggests this inverse relationship holds. We examine the relationship between risk aversion and IES using household consumption data from the Consumer Expenditure Survey during 1996 -2010. Multiple risk domains are selected to represent risk preference; for each domain we consider some households to be more risk averse than others. We separately estimate IES for the more risk averse households and the less risk averse households. We find that the IES estimates are generally smaller for the more risk averse households than for the less risk averse households and the difference is statistically significant in majority of the financial domains. This finding supports the inverse relationship between the two parameters, though considerable heterogeneity is found across domains. Abstract Word Count: 166Word Count: 166