Time Complementarity and the Behavior of Asset Returns

Abstract

The testable restrictions on the behavior of asset returns are investigated when variable time preference exhibits time complementarity. It is shown that as time complementarity (i.e., temporal risk preference) increases, the volatility of asset prices increases. It is also shown that time complementarity helps explain excessively volatile asset returns and excessively smooth consumption growth. Our empirical study confirms this result. Variable time preference exhibiting time complementarity improves the overall fitness but there is a substantial evidence when the restrictions are imposed simultaneously for different assets. Consumption from services appears to be a major source of the empirical puzzles documented in the literature.