Quarto Encontro de Economia do Espírito Santo (IV EEES). Quality Hotel Aeroporto Vitória, Vitória, 04 de Novembro de 2013.

1. Comments on ’Large Estimates of the
Elasticity of Intertemporal Substitution: is
it the aggregate return series or the
instrument list?’
by F´bio Gomes and Louren¸o Paz
a
c
Matheus Albergaria de Magalh˜es1
a
1 Instituto
Jones dos Santos Neves (IJSN) and FUCAPE Business School
Quarto Encontro de Economia do Esp´
ırito Santo (IV EEES)
.
November 4th , 2013

2. Organization
Contribution
Motivation
Suggestions
Conclusions
References

3. Contribution
Main focus of the paper: elasticity of intertemporal
substitution (EIS).
Authors revisit estimation issues related to the EIS (e.g.,
Gomes and Paz 2013a).
Two main contributions:
1. Investigate if Mulligan’s (2002) estimates are plagued by the
weak instrument problem (Stock, Wright and Yogo 2002).
2. Estimate Mulligan’s specifications using Yogo’s (2004) and
Dacy and Hasanov’s (2011) instrument sets.

4. Contribution
Results indicate that Mulligan’s (2002) aggregate capital
return series is able to deliver relatively large and statistically
significant estimates of the EIS (greater than one).
Additionaly, Mulligan’s original instrument set does not suffer
from the weak instrument problem.
Conclusion: the aggregate capital return series constructed by
Mulligan (2002) is the reason behind large EIS estimates.

5. Motivation
EIS: why should we care?
Economists have worried about EIS issues for a long time
(e.g., Hansen 1985).
EIS is an important parameter in several areas of Economics
and Finance.
A few examples:
1. Effects of inflation.
2. Incidence effects of capital taxes.
3. Aggregate effects of financial intermediation.
4. Business-Cycle analysis.

6. Motivation
Problem: empirical literature produced very mixed results.
Time-series studies: EIS values close to 0.
Panel Data studies: EIS values around 1.
Results seem to depend on measure used as proxy for the
expected real rate of return (generally not observed) (Murray
2006).

7. Motivation
EIS - Country Heterogeneity
Source: Havranek et al. (2013, Fig.2, p.7).

8. Motivation
EIS - Method Heterogeneity
Source: Havranek et al. (2013, Fig.3, p.8).

9. Motivation
EIS - Impact Heterogeneity
Source: Havranek et al. (2013, Fig.1, p.2).

10. Suggestions
Authors present a very interesting analysis.
I learned a great deal from this paper.
My suggestions will focus mainly on future research.

11. Suggestions
Suggestion 1: estimate EIS through cointegration techniques.
Favero (2005) used a recursive Epstein-Zin utility function
and a linearized intertemporal budget constraint to derive an
explicit long-run consumption function.
New possibility: evaluation of future discounted labour
income growth as a determinant of the current value of
human capital.

12. Suggestions
Suggestion 2: use capital income tax rate.
Motivation: conditional on observable characteristics of
individuals, tax rate movements cause exogenous shifts in the
after-tax interest rate.
Using data on total non-durable consumption from the
Consumer Expenditure Survey (CEX) over a two-decade
period, Gruber (2006) estimates a surprisingly high value for
the EIS (around 2).
New possibility: Mulligan’s aggregate return series may not
be the only reason behind large values for the EIS.

13. Conclusions
At the end of the day, EIS still poses an empirical puzzle for
economists.
Weak instruments seem to be a major concern in this case...
...but I feel that the search for aggregate return series may
provide more interesting (and intuitive) answers in the near
future.
Conclusion: authors should focus on finding empirical
measures that reflect EIS on theoretical grounds.

14. References
DACY, D.; HASANOV, F. A finance approach to estimating consumption parameters.
Economic Inquiry, v.49, n.1, p.122-154, 2011.
FAVERO, C.A. Consumption, wealth, the elasticity of intertemporal substitution and
long-run stock market returns. Bocconi University, Mimeo., Nov.2005, 26p.
GOMES, F.A.; PAZ, L.S. Estimating the elasticity of intertemporal substitution: is the
aggregate financial return free from the weak instrument problem? Journal of
Macroeconomics, v.36, n.1, p.63-75, Feb.2013 [2013a].
GOMES, F.A.; PAZ, L.S. Large estimates of the elasticity of intertemporal
substitution: is the aggregate return series or the instrument list? Quarto Encontro de
Economia do Esp´
ırito Santo (IV EEES). Anais..., Nov.2013, 11p. [2013b].

15. References
GRUBER, J. A tax-based estimate of the elasticity of intertemporal substitution.
NBER working paper n.11945, Jan.2006, 30p.
HANSEN, Gary D. Indivisible labor and the business cycle. Journal of Monetary
Economics, v.16, n.3, p.309-327, 1985.
HAVRANEK, T.; HORVATH, R.; IRSOVA, Z.; RUSNAK, M. Cross-country
heterogeneity in intertemporal substitution. Charles University, Mimeo., Aug.2013,
39p.
MULLIGAN, C.B. Capital, interest, and aggregate intertemporal substitution. NBER
working paper n.9373, Dec.2002, 45p.

16. References
MURRAY, M.P. Avoiding invalid instruments and coping with weak instruments.
Journal of Economic Perspectives, v.20, n.4, p.111-132, Fall 2006.
STOCK, J.H.; WRIGHT, J.H.; YOGO, M. A survey of weak instruments and weak
identification in Generalized Method of Moments. Journal of Business & Economic
Statistics, v.20, n.4, p.518-529, Oct.2002.
YOGO, M. Estimating the elasticity of intertemporal substitution when instruments
are weak. Review of Economics and Statistics, v.86, n.4, p.797-810, 2004.

17. Thank You
Matheus Albergaria de Magalh˜es
a
matheus.albergaria.magalhaes@gmail.com
http://www.sites.google.com/site/malbergariademagalhaes