Estimating the Elasticity of Intertemporal Substitution When Instruments Are Weak
38 Pages Posted: 18 Jan 2009 Last revised: 12 Mar 2014
Date Written: December 13, 2003
Abstract
In the instrumental variables (IV) regression model, weak instruments can lead to bias in estimators and size distortion in hypothesis tests. This paper examines how weak instruments affect the identification of the elasticity of intertemporal substitution (EIS) through the linearized Euler equation. Conventional IV methods result in an empirical puzzle that the EIS is significantly less than one while its inverse is not different from one. This paper shows that weak instruments can explain the puzzle and reports valid confidence intervals for the EIS using pivotal statistics. The EIS is less than one and not significantly different from zero for eleven developed countries.
JEL Classification: C12, E21, G12
Suggested Citation: Suggested Citation
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