Testing Volatility Restrictions on Intertemporal Marginal Rates of Substitution Implied by Euler Equations and Asset Returns

Authors

  • STEPHEN G. CECCHETTI,

  • POK-SANG LAM,

  • NELSON C. MARK

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    • Department of Economics, Ohio State University and NBER; Department of Economics, Ohio State University; and Department of Economics, Ohio State University, respectively. We thank James Bodurtha, In Choi, John Campbell, John Cochrane, Benjamin Friedman, Lars Hansen, John Heaton, Edward Kane, Leonard Santow, Robert Stambaugh, Alan Viard, an anonymous referee, the participants at the NBER Asset Pricing Program Meeting and the seminars at Ohio State, Indiana, and Princeton for helpful comments and suggestions. Cecchetti thanks the National Science Foundation for financial support.

ABSTRACT

The Euler equations derived from intertemporal asset pricing models, together with the unconditional moments of asset returns, imply a lower bound on the volatility of the intertemporal marginal rate of substitution. This paper develops and implements statistical tests of these lower bound restrictions. While the availability of short time series of consumption data often undermines the ability of these tests to discriminate among different utility functions, we find that the restrictions implied by a number of widely studied financial data sets continue to pose quite a challenge to the current generation of intertemporal asset pricing theories.

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