5
$\begingroup$

One of the well known paradoxes in macroeconomics is that estimates of risk aversion from experimental micro data do not match the ones estimated from macro data.

I know there was an important paper that pointed this out first but I forgot the name of author(s) and title. Does anyone know what paper it is?

$\endgroup$
2
  • 3
    $\begingroup$ Are you thinking about Mehra & Prescott 1985? $\endgroup$ Oct 21 at 22:41
  • $\begingroup$ @MichaelGreinecker yes that's it! If you post it as an answer I will accept it. Thanks $\endgroup$
    – csilvia
    Oct 29 at 18:53

2 Answers 2

3
$\begingroup$

In an extremely influential paper, Mehra and Prescott (the reference is below) showed that in order to explain the premium of stocks over treasury bonds in a parametric general equilibrium model, one needs to assume levels of risk aversion that are a magnitude higher than what one usually assumes. However, the difference is not so much with microeconomics than what is reasonable for other problems. The difference between microeconomics and macroeconomics is not that clear though. It should also be noted that risk aversion in laboratory experiments is much higher than what appears reasonable. For the tiny sums involved, one would expect subjects to behave as if they were risk-neutral. They do not.

Mehra, Rajnish, and Edward C. Prescott. "The equity premium: A puzzle." Journal of Monetary Economics 15.2 (1985): 145-161.

$\endgroup$
2
  • $\begingroup$ I have read this paper a long time ago- but to what extent is this a paradox, or simply an artefact of their heavily parametrized model? To what extent is this a puzzle rather than a functional form misspecification, for instance? $\endgroup$ Nov 7 at 2:38
  • $\begingroup$ There is a huge literature reacting to the paper, the view articulated by you can be found there too. $\endgroup$ Nov 7 at 8:40
3
$\begingroup$

The literature was initially quite pessimistic about the possibility to consistently estimate risk-aversion parameters consistently (and more generally all models' parameters), as highlighted by

Carroll, Christopher Dixon, 2001, "Death to the Log-Linearized Consumption Euler Equation! (And Very Poor Health to the Second-Order Approximation)," The B.E. Journal of Macroeconomics, 1(1).

However, provided the time horizon is long enough, there is some hope to estimate the parameters consistently from micro-data, as discussed by:

Attanasio, Orazio, P. and Hamish Low, 2004, "Estimating Euler equations," Review of Economic Dynamics, 7, 405–435.

Regarding the macroeconomic literature, the issue of consistent estimation cannot be investigated at all with macro data, as aggregation over individuals is only possible under strict conditions. For a study illustrating how "the size of the bias increases with the level of aggregation", see for instance:

Cutanda, A., J.M. Labeaga, and J.A. Sanchis-Llopis, 2020, "Aggregation biases in empirical Euler consumption equations: evidence from Spanish data," Empirical Economics, 58, 957–977.

Well, this does not identify which is precisely the original paper showing the inconsistency between the micro and macro estimates, but rather tend to give support to the thesis according to which macro estimates are inconsistent, and micro estimates can be consistent for the true parameters, under some reasonable conditions.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.