macroeconomics, utility-functionThis is one for the macro people (although microeconomists can probably answer this too). A fasionable new tool in dynamic macro is Epstein-Zin utility. Unlike a lot of micro models, Epstein-Zin has found many applications and is therefore quite popular. Can someone tell me what its main features are and exactly why it’s popular among macroeconomists?
The quick answer is that the “standard” CRRA (“Constant Relative Risk Aversion;” more on that later perhaps) forces agents to treat “risk aversion” and “intertemporal substitution” as strictly and statically to each other. That is, if we have some measure of risk aversion, alpha, and some measure of intertemporal substitution, beta, then the “standard” CRRA agent has this relationship forced between the two by the nature of the utility function:
$\alpha=\frac{1}{\beta}$
So when you set one you automatically set the other. The Epstein-Zin preferences relax this, such that you can set them separately from each other. (More explanation to come…)
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