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Journal of Financial Econometrics Advance Access originally published online on August 11, 2007
Journal of Financial Econometrics 2007 5(4):523-559; doi:10.1093/jjfinec/nbm013
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Copyright © The Author 2007. Published by Oxford University Press.

A Statistical Inquiry into the Plausibility of Recursive Utility

A. Ronald Gallant
     Duke University

Han Hong
     Stanford University

Address correspondence to A. Ronald Gallant, Duke University, Fuqua School of Business, DUMC 90120, Durham NC 27708-0120, USA, or e-mail: arg{at}duke.edu


  Abstract

We use purely statistical methods to determine if the pricing kernel is the intertemporal marginal rate of substitution under recursive utility. We introduce a nonparametric Bayesian method that treats the pricing kernel as a latent variable and extracts it and its transition density from payoffs on 24 Fama-French portfolios, on bonds, and on payoffs that use conditioning information available when portfolios are formed. Our priors are formed from an examination of a Bansal-Yaron economy. Using both monthly data and annual data, we find that the data support recursive utility.

KEYWORDS: recursive utility, asset pricing, statistical methods

This work was supported by National Science Foundation Grant Numbers SES 0438174 (Gallant) SES 0452143 (Hong). We thank Lars Peter Hansen, Christian Gouriéroux, and Michael Pitt for their comments.

Received June 2, 2006; revised June 1, 2007; accepted July 18, 2007


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