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Consumption, Wealth, the Elasticity of Intertemporal Substitution and Long-Run Stock Market Returns

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  • Favero, Carlo A

Abstract

Consumption is striking back. Some recent evidence indicates that the well-known asset pricing puzzles generated by the difficulties of matching fluctuations in asset prices with high frequency fluctuations in consumption might be solved by considering consumption in the long-run. A first strand of the literature concentrates on multiperiod differences in log consumption, a second concentrates on the cointegrating relation for consumption. Interestingly, only the (multiperiod) Euler Equation for the consumer optimization problem is considered by the first strand of the literature, while the cointegration-based literature concentrates exclusively on the (linearized) intertemporal budget constraint. In this paper, we show that using the first order condition in the linearized budget constraint to derive an explicit long-run consumption function delivers an even more striking strike back.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5110.

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Date of creation: Jun 2005
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Handle: RePEc:cpr:ceprdp:5110

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Keywords: cointegrating consumption function; elasticity of intertemporal substitution; long-run stock market returns;

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  1. Ravi Bansal & Robert F. Dittmar & Christian T. Lundblad, 2005. "Consumption, Dividends, and the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 60(4), pages 1639-1672, 08.
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Cited by:
  1. Bertrand Wigniolle, 2011. "Savings behavior with imperfect capital markets: when hyperbolic discounting leads to discontinuous strategies," Documents de travail du Centre d'Economie de la Sorbonne 11028, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
  2. Chang, Yanqin, 2007. "high level of international risk sharing when the productivity growth contains long run risk," MPRA Paper 4476, University Library of Munich, Germany.
  3. Growiec Jakub, 2006. "Fertility Choice and Semi-Endogenous Growth: Where Becker Meets Jones," The B.E. Journal of Macroeconomics, De Gruyter, vol. 6(2), pages 1-25, September.
  4. Knapp, Keith C. & Franklin, Bradley, 2012. "Sustainability Economics of Groundwater Usage and Management," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124959, Agricultural and Applied Economics Association.
  5. Ricardo M. Sousa, 2007. "Expectations, Shocks, and Asset Returns," NIPE Working Papers 29/2007, NIPE - Universidade do Minho.
  6. Ricardo Sousa, 2011. "Building proxies that capture time-variation in expected returns using a VAR approach," Applied Financial Economics, Taylor & Francis Journals, vol. 21(3), pages 147-163.

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