The Effect of Temporal Risk Aversion on Optimal Consumption, the Equity Premium, and the Equilibrium Interest Rate



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    • School of Management, the University of Texas at Dallas, I wish to thank Ron Kudla, Lemma Senbet, Ken Singleton, René Stulz (the editor), an anonymous referee, and especially Richard Green and Howard Thompson for valuable comments, along with seminar participants at the University of Wisconsin-Madison, the third international convention of Korean Economists, and the 1988 WFA meetings. I am grateful to Richard Green for bringing the problem to my attention.


This paper demonstrates that temporal risk aversion makes smoothing consumption over time less attractive, while the usual risk aversion makes it more attractive. As temporal risk aversion increases, the equilibrium interest rate decreases and the equity premium increases. This paper also shows a striking and novel result that an increase in time impatience can lead to either a decrease or an increase in the interest rate, depending on the nature of the nonseparability.