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Measuring the Dynamic Cost of Living Index from Consumption Data

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  • Aoki, Shuhei
  • Kitahara, Minoru

Abstract

In the U.S., the objective of consumer price index (CPI) measurement is to measure the cost of living. However, the current CPI or, in other words, cost of living index (COLI) measures the cost of living in a static optimization problem. This paper proposes a new method to construct a dynamic cost of living index (DCOLI). Our method offers several advantages compared to other dynamic cost of living indices proposed in the literature. First, our measure is based on total wealth. Previous indices limited attention to financial wealth. Second, we consider an Epstein-Zin preference structure. Most previous literature has used log preferences. We derive formulas that relate our DCOLI to the COLI and derive conditions under which the two coincide. We also produce empirical measures of our DCOLI. We find that under standard assumptions on preferences, the volatility of our DCOLI is about the same as that of the COLI. In certain periods, e.g., 1977–1983, our measure differs sharply from the COLI.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 9802.

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Date of creation: 02 Aug 2008
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Handle: RePEc:pra:mprapa:9802

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Keywords: dynamic cost of living index; cost of life; CPI;

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  1. Jagannathan, Ravi & Wang, Zhenyu, 1996. " The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 51(1), pages 3-53, March.
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  5. Lustig, Hanno & van Nieuwerburgh, Stijn & Verdelhan, Adrien, 2012. "The Wealth-Consumption Ratio," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9022, C.E.P.R. Discussion Papers.
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  7. Martin Lettau, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 56(3), pages 815-849, 06.
  8. Michael F. Bryan & Stephen G. Cecchetti & Roisin O'Sullivan, 2002. "Asset Prices in the Measurement of Inflation," NBER Working Papers 8700, National Bureau of Economic Research, Inc.
  9. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(2), pages 263-86, April.
  10. Alchian, Armen A & Klein, Benjamin, 1973. "On a Correct Measure of Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 5(1), pages 173-91, Part I Fe.
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  12. R. Anton Braun & Julen Esteban-Pretel & Toshihiro Okada & Nao Sudou, 2005. "A Comparison of the Japanese and U.S. Business Cycles," CIRJE F-Series, CIRJE, Faculty of Economics, University of Tokyo CIRJE-F-392, CIRJE, Faculty of Economics, University of Tokyo.
  13. Reis, Ricardo, 2005. "A cost-of-living dynamic price index, with an application to indexing retirement accounts," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5394, C.E.P.R. Discussion Papers.
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