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

Recent financial studies often assume agents have Epstein and Zin (1989) preferences, preferences which 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. After classifying subjects in a finite mixture model by their risk, time and intertemporal-substitution parameters, regression results show that types predicted by Epstein-Zin to prefer early resolution choose early resolution with 20–50% higher probability