Risk Aversion versus Intertemporal Substitution: A Case Study of Identification Failure in the Intertemporal Consumption Capital Asset Pricing Model.

Is the risk-aversion parameter in the intertemporal consumption capital asset pricing model "small" as stated by Hansen and Singleton or is its reciprocal--the intertemporal elasticity of substitution--small, as stated by Hall? We attribute the disparate estimates of this fundamental parameter not to failures of instrument admissibility as do Hall and Hansen and Singleton but rather to failures of instrument relevance. That is, the disparate estimates reflect near nonidentification due to the unpredictability of asset returns and consumption growth. Imposing natural identifying restrictions from the risk-aversion perspective and the intertemporal substitution perspective yields low and stable estimates in each case.