A Household’s Preferences Vary Depending on Whether Incomes Are Permanent or Temporary: A Solution to the Time-Inconsistency Problem and Equity-Premium Puzzle

Harashima, Taiji (2022): A Household’s Preferences Vary Depending on Whether Incomes Are Permanent or Temporary: A Solution to the Time-Inconsistency Problem and Equity-Premium Puzzle.

Abstract

A household’s preferences are usually assumed not to vary temporally or depending on the objects to which they are applied, but this assumption is often inconsistent with empirical estimates, for example, with the time-inconsistency problem of the time preference rate and the equity-premium puzzle. I show that these inconsistencies are generated because a household’s preferences vary depending on whether they are applied to permanent or temporary incomes. Preferences applied to permanent incomes are anchored to the steady state or a balanced growth path, but those for temporary incomes are not. Hence, the former are fixed and unchanged, but the latter can take various values depending on conditions.

• Item Type: MPRA Paper
• Language: English
• Keywords: Equity premium; Permanent income; Risk aversion; Temporary income; Time inconsistency; Time preference
• Subjects: D - Microeconomics > D1 - Household Behavior and Family Economics > D10 - General; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E21 - Consumption ; Saving ; Wealth

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