Intertemporal Elasticity of Substitution with Leisure Margin

Takeshi Yagihashi,Juan Du

doi:10.2139/ssrn.3050099

Abstract

This paper investigates whether leisure time definitions matter in the estimation of the intertemporal elasticity of substitution of consumption (IES) by using a utility specification that allows interaction between consumption and leisure time. We find that the IES estimated using a narrowly defined leisure measure that excludes quasi-leisure activities is larger than that estimated using nonmarket time. The discrepancy is largely driven by the substitution of consumption and several leisure components over the lifecycle. This finding is robust in alternative specifications and holds well for subsamples of higher socioeconomic status. Our results demonstrate the inseparable nature of consumption and time allocation.

Highlights

Intertemporal elasticity of substitution (IES) is widely regarded as one of the key mechanisms that influence consumption and saving behavior observed in the aggregate economy
As distinct from earlier studies that focus on labor hours or nonmarket time, our paper explores how subsets of leisure measures affect the intertemporal elasticity of substitution of consumption (IES) estimates by jointly estimating consumption and leisure Euler equations
We incorporate time diary data to construct detailed leisure measures, which enables us to explore the effect of different leisure components on the IES estimates

Summary

Introduction

Intertemporal elasticity of substitution (IES) is widely regarded as one of the key mechanisms that influence consumption and saving behavior observed in the aggregate economy. Due to the substitution between consumption and quasi-leisure activities ( for individuals with higher socioeconomic status), the IES estimate tends to be low when nonmarket time is used in estimation. This result challenges the common practice of treating nonmarket time as the proxy for leisure. In addition to confirming the general importance of nonseparable preferences in the context of consumption and saving behavior, we extend previous studies by testing the substitutability between consumption and different leisure components, which allows us to identify the leisure component(s) that has the largest impact on IES estimates.

Theoretical Framework

Findings

Conclusions