Intertemporal Substitution, Risk and the Time Series Behaviour of Consumption and Asset Returns

This paper studies the time series behaviour of aggregate consumption and asset returns when the representative agent does not (necessarily) maximize the expected value of a von Neumann-Morgenstern utility index. By assuming that agent's intertemporal preferences over stochastic consumption sequences have the multiperiod analogue of the Ordinal Certainty Equivalent representation of Selden (1978, 1979), testable implications for the joint behaviour of consumption and assets returns are derived. These preferences contain the conventional von Neumann-Morgenstern representation as a special case and allow for "risk preference" and "time preference" to be modelled independently. The model is estimated and tested using monthly U.S. data on non-durable consumption, treasury bill returns, and corporate bond returns.