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Epstein-Zin Preferences And Their Use In Macro-Finance Models: Implications For Optimal Monetary Policy

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Executive Summary

Epstein-Zin preferences have attracted significant attention within the macro-finance literature based on DSGE models as they allow substantially increasing risk aversion, and consequently generating non-trivial risk premia, without compromising the ability of standard models to achieve satisfactory macroeconomic data coherence. Such appealing features certainly hold for structural modeling frameworks where monetary policy is set according to Taylor-type rules or seeks to minimize an ad hoc loss function under commitment. However, Epstein-Zin preferences may have significant quantitative implications for both asset pricing and macroeconomic allocation under a welfare-based monetary policy conduct.

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