I am unable to understand the concept of intertemporal rate of substitution. I have understood the meaning of marginal utility of current and future consumptions. But, not able to apply the concept in questions
May you please help me here with an example.
Hi Vinit,
This 2 questions are a bit tricky. You need to be careful while reading the question, 1st one speak about the covariance b/w security price & MU which is -ve, formula is E(P1) – Cov{E(P1), MU}
2nd question is talking about the correlation b/w asset return & future consumption during bad times i.e., when ERP demanded by a risk averse investor is high & asset return is low so the correlation is +ve
The key point to remember is, they’re talking about future consumption & not Marginal utility of future consumption, MUfc & asset return has a -ve correlation and, not fc & asset return.
I hope this will help you in understanding. Thank you!
May you better explain the concept of Intertemporal Rate of Substitution with an example.