Weak Instruments, Degree of Risk Aversion and Equity Premium: Evidence from Singapore, South Korea and Taiwan

Using data from Singapore, South Korea, and Taiwan, we estimate the coefficient of relative risk aversion (RRA) in the constant relative risk aversion utility specification of the consumption-based capital asset pricing model. Conventional instrumental variables methods find that the coefficient of RRA is low but the inverse of it—the elasticity of intertemporal substitution in consumption—is also low. Such contradictory findings could be attributed to instruments being weak. Using weak-instrument robust tests, we find from the equity market data that the coefficient of RRA is rather high, which could potentially explain the high equity premiums in these three East Asian economies.