Do Individuals Have Preferences Used in Macro-Finance Models? An Experimental Investigation

Recent financial studies often assume agents have Epstein and Zin (1989) preferences, preferences which require agents to care about when uncertainty is resolved. Under this “recursive-preference” framework, the preference for uncertainty resolution is entirely determined by an agent’s preferences for risk and intertemporal substitution. To test the implications of this model, this paper presents a set of experiments designed to elicit subject preferences on risk, time, intertemporal substitution, and uncertainty resolution. Results reveal that most subjects prefer early resolution of uncertainty and have relative risk aversion greater than the reciprocal of the elasticity of intertemporal substitution, consistent with the predictions by recursive preferences. After classifying subjects in a finite mixture model by their risk, time and intertemporal-substitution parameters, regression results show that types predicted by Epstein-Zin to prefer early resolution choose early resolution with 20–50% higher probability. JEL: G11, C91, G12, D53 ∗This paper benefitted from presentations at the 2010 World Economic Science Association meetings, the 2010 North American Economic Science Association meetings and the University of Texas at Dallas. The authors thank Catherine Eckel, Ernan Haruvy, Shane Johnson, Sorin Sorescu and Tim Salmon for comments, Zack Bethune, Darshan Sukumaran, and Yue Zhang for help with running experiments and/or transcribing survey data. †Corresponding author. Please contact at [email protected]. ‡Email: [email protected].