This paper reports measures of preference parameters relating to risk tolerance, time preference, and intertemporal substitution. These measures are based on survey responses to hypothetical situations constructed using an economic theorist's concept of the underlying parameters. The individual measures of preference parameters display heterogeneity. Estimated risk tolerance and the elasticity of intertemporal substitution are essentially uncorrelated across individuals. Measured risk tolerance is positively related to risky behaviors, including smoking, drinking, failing to have insurance, and holding stocks rather than Treasury bills. These relationships are both statistically and quantitatively significant, although measured risk tolerance explains only a small fraction of the variation of the studied behaviors. Robert B. Barsky F. Thomas Juster Miles S. Kimball Matthew D. Shapiro Survey Research Center and Department of Economics University of Michigan Ann Arbor, MI 48109 tel. 313 ...

This paper argues that the typical household’s saving is better described by a “bufferstock” version than by the traditional version of the Life Cycle/Permanent Income Hypothesis (LC/PIH) model. Buffer-stock behavior emerges if consumers with important income uncertainty are sufficiently impatient. In the traditional model, consumption growth is determined solely by tastes; in contrast, buffer-stock consumers set average consumption growth equal to average labor income growth, regardless of tastes. The model can explain three empirical puzzles: the “consumption/income parallel ” of Carroll and Summers [1991]; the “consumption/income divergence ” first documented in the 1930's; and the temporal stability of the household age/wealth profile despite the unpredictability of idiosyncratic wealth changes.

this paper with an empirical investigation into some of the risk factors and demographic variables that might explain these cross-sectional differences in portfolio composition. A number of previous studies have focused on the level and variability of wage income growth as one of the largest sources of undiversifiable income risk. Here we present evidence that, for the subset of the population that has significant stock holdings, income from entrepreneurial ventures (which we refer to as proprietary business income) represents a large source of undiversifiable risk that is more highly correlated with common stock returns. These findings motivate the investigation in the second part of the paper of a linear asset pricing model that incorporates proprietary income from privately held businesses as a risk factor.

Within the expected-utility framework, the only explanation for risk aversion is that the utility function for wealth is concave: A person has lower marginal utility for additional wealth when she is wealthy than when she is poor. This paper provides a theorem showing that expected-utility theory is an utterly implausible explanation for appreciable risk aversion over modest stakes: Within expected-utility theory, for any concave utility function, even very little risk aversion over modest stakes implies an absurd degree of risk aversion over large stakes. Illustrative calibrations are provided.

This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work and on the trade-off between risk and return. Modern research seeks to understand the behavior of the stochastic discount factor ~SDF! that prices all assets in the economy. The behavior of the term structure of real interest rates restricts the conditional mean of the SDF, whereas patterns of risk premia restrict its conditional volatility and factor structure. Stylized facts about interest rates, aggregate stock prices, and cross-sectional patterns in stock returns have stimulated new research on optimal portfolio choice, intertemporal equilibrium models, and behavioral finance. This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work. Theorists develop models with testable predictions; empirical researchers document “puzzles”—stylized facts that fail to fit established theories—and this stimulates the development of new theories. Such a process is part of the normal development of any science. Asset pricing, like the rest of economics, faces the special challenge that data are generated naturally rather than experimentally, and so researchers cannot control the quantity of data or the random shocks that affect the data. A particularly interesting characteristic of the asset pricing field is that these random shocks are also the subject matter of the theory. As Campbell, Lo, and MacKinlay ~1997, Chap. 1, p. 3! put it: What distinguishes financial economics is the central role that uncertainty plays in both financial theory and its empirical implementation. The starting point for every financial model is the uncertainty facing investors, and the substance of every financial model involves the impact of uncertainty on the behavior of investors and, ultimately, on mar-* Department of Economics, Harvard University, Cambridge, Massachusetts

We examine the relationship between income growth and saving using both cross-country and household data. At the aggregate level, we find that growth Granger causes saving, but saving does not Granger cause growth. Using household data, we find that households with predictably higher income growth save more than households with predictably low growth. We argue that standard permanent income models of consumption cannot explain these findings, but, a model of consumption with habit formation may. The positive effect of growth on saving implies that previous estimates of the effect of saving on growth may be overstated.

This paper solves a realistically calibrated life-cycle model of consumption and portfolio choice with uninsurable labor income risk and borrowing constraints. Since labor income substitutes for riskless asset holdings the optimal share invested in equities is roughly decreasing over life. We compute a measure of the importance of non-tradable human capital for investment behavior to find that ignoring labor income generates large utility costs, while the cost of ignoring only its risk is an order of magnitude smaller. We also quantify the utility cost associated with typical heuristics advocated by financial advisors. The issue of portfolio choice over the life-cycle is encountered by every investor. Popular finance books (e.g. Malkiel, 1996) and financial counselors generally give the advice to shift the portfolio composition towards relatively safe assets, such as T-bills, and away from risky stocks as the investor grows older and reaches retirement. But what could be the economic

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Constantinides and Due (1996) show that for idiosyncratic risk to matter for asset pricing the shocks must (i) be highly persistent and (ii) become more volatile during economic contractions. We show that data from the Panel Study on Income Dynamics (PSID) are consistent with these requirements. Our results are based on econometric methods which incorporate macroeconomic information going beyond the time horizon of the PSID, dating back to 1910. We go on to argue that life-cycle effects are fundamental for how idiosyncratic risk affects asset pricing. We use a stationary overlapping-generations model to show that life-cycle effects can either mitigate or accentuate the equity premium, the critical ingredient being whether agents accumulate or deccumulate risky assets as they age. Our model predicts the latter and is able to account for both the average equity premium and the Sharpe ratio observed on the U.S. stock market.

: Traditional theories of intermediation are based on transaction costs and asymmetric information. They are designed to account for institutions which take deposits or issue insurance policies and channel funds to firms. However, in recent decades there have been significant changes. Although transaction costs and asymmetric information have declined, intermediation has increased. New markets for financial futures and options are mainly markets for intermediaries rather than individuals or firms. These changes are difficult to reconcile with the traditional theories. We discuss the role of intermediation in this new context stressing risk trading and participation costs. Keywords : intermediation, risk management delegated monitoring, banks, participation costs JEL Classification : 310, 020, 610 1. Introduction In this paper we review the state of intermediation theory and attempt to reconcile it with the observed behavior of institutions in modern capital markets. We argue...