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Can risk aversion really explain the negative investment-uncertainty relationship?

Saltari, Enrico and Ticchi, Davide Can risk aversion really explain the negative investment-uncertainty relationship? Working Paper # /2000 (Unpublished)

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This paper shows the role of risk aversion and intertemporal substitutability in the investment-uncertainty relationship. Using recursive preferences, the paper demonstrates that not only the degree of risk aversion is important in determining the sign of the investmentuncertainty relationship but that the intertemporal substitution elasticity also plays a crucial role. This cannot be captured in the traditional expected utility set-up as risk aversion and intertemporal substitutability are determined by the same parameter. In particular, the paper shows that risk aversion can explain the negative relationship between investment and uncertainty only in a static context. In a dynamic framework, the linkage between periods can lead risk aversion to have a positive e¤ect on investment when uncertainty increases. Indeed, the e¤ects deriving from the linkage between periods depend by the intertemporal substitution elasticity: under low intertemporal substitutability, greater risk aversion can lead to higher investment when uncertainty increases. Moreover, the paper shows that with CRRA preferences investment should be positively correlated with the degree of uncertainty for reasonable values of the coe¢cient of relative risk aversion

Item Type: Working Paper (Working Paper)
Uncontrolled Keywords: JEL Classification: D81, D92, E22
Subjects: H Social Sciences > HB Economic Theory
Research Area: Economics and Institutional Change
Depositing User: Ms T. Iannizzi
Date Deposited: 30 Jun 2014 13:00
Last Modified: 30 Jun 2014 13:00
URI: http://eprints.imtlucca.it/id/eprint/2220

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