Estimating the Elasticity of Intertemporal Substitution Using Mortgage Notches
Using a novel source of quasi-experimental variation in interest rates, we develop a new approach to estimating the Elasticity of Intertemporal Substitution (EIS). In the UK, the mortgage interest rate features discrete jumps – notches – at thresholds for the loan-to-value (LTV) ratio. These notches generate large bunching below the critical LTV thresholds and missing mass above them. We develop a dynamic model that links these empirical moments to the underlying structural EIS. The average EIS is small, around 0.1, and quite homogeneous in the population. This finding is robust to structural assumptions and can allow for uncertainty, a wide range of risk preferences, portfolio reallocation, liquidity constraints, present bias, and optimization frictions. Our findings have implications for the numerous calibration studies that rely on larger values of the EIS.
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Copy CitationMichael Carlos Best, James Cloyne, Ethan Ilzetzki, and Henrik Kleven, "Estimating the Elasticity of Intertemporal Substitution Using Mortgage Notches," NBER Working Paper 24948 (2018), https://doi.org/10.3386/w24948.Download Citation
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Published Versions
Michael Carlos Best & James S Cloyne & Ethan Ilzetzki & Henrik J Kleven, 2020. "Estimating the Elasticity of Intertemporal Substitution Using Mortgage Notches," Review of Economic Studies, Oxford University Press, vol. 87(2), pages 656-690. citation courtesy of 
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