This paper evaluates models with idiosyncratic consumption risk using Hansen and Jagannathan’s (1991) volatility bounds. It is shown that idiosyncratic risk does not change the volatility bounds at all when consumers have constant relative risk aversion (CRRA) preferences and the distribution of the idiosyncratic shock is independent of the aggregate state. Following Mankiw (1986), I show that idiosyncratic risk can help to enter the bounds when idiosyncratic uncertainty depends on the aggregate state of the economy. Since individual consumption data is not reliable, I compute an upper bound of the volatility bounds using individual income data and assume that agents must consume their endowment. I find that the model does not pass the Hansen and Jagannathan test even for very volatile idiosyncratic income data.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
1795.
Find related papers by JEL classification: E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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