Do Individuals Have Preferences Used in Macro-Finance Models? An Experimental Investigation

Recent financial studies often assume that agents have Epstein–Zin preferences—preferences that require agents to care about when uncertainty is resolved. Under this “recursive-preference” framework, the preference for uncertainty resolution is entirely determined by an agent's preferences for risk and intertemporal substitution. To test the implications of this model, this paper presents an experiment designed to elicit subject preferences on risk, time, intertemporal substitution, and uncertainty resolution. Results reveal that most subjects prefer early resolution of uncertainty and have relative risk aversion greater than the reciprocal of the elasticity of intertemporal substitution, consistent with the predictions by recursive preferences. Subjects are classified in a finite mixture model by their risk, time, and intertemporal-substitution parameters. Regression results show that types predicted by the Epstein–Zin model to prefer early resolution choose early resolution with 20%–50% higher probability.

Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1794

This paper was accepted by Brad Barber, finance.