The Rate of Interest or the Rate of Return: Estimating Intertemporal Elasticity of Substitution

Douglas Dacy and Fuad Hasanov
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Douglas Dacy: University of Texas at Austin

Macroeconomics from EconWPA

Abstract: This paper investigates whether the rate of interest such as the Treasury bill rate or the rate of return such as the return on a household portfolio is more relevant to the household’s intertemporal decision making. In a current era, households are diversifiers (to use Tobin’s 1958 term) and hold portfolios of assets rather than a simple loan. A portfolio of assets earns a composite return accounting for capital gains, taxes, and inflation, and rational agents make spending decisions based on expected total returns on a portfolio rather than on the return on a single asset. The total composite measure we use includes financial assets such as stocks and bonds and a real asset, residential housing. In particular, we estimate the intertemporal elasticity of substitution, namely, how a change in the asset or portfolio return affects household’s consumption growth. The estimates obtained using real after-tax composite return are about 0.15-0.3 and are more robust to linear and nonlinear estimations, different consumption measures, and various time periods than those obtained by using individual asset returns such as the Treasury bill rate.

Keywords: intertemporal elasticity of substitution; intertemporal choice; consumption; housing; portfolio return (search for similar items in EconPapers)
JEL-codes: D91 E21 C13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac and nep-mic
Date: 2005-10-11
Note: Type of Document - pdf
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpma:0510012

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