Advanced Search
MyIDEAS: Login to save this paper or follow this series

High-Order Consumption Moments and Asset Pricing

Contents:

Author Info

  • Andrei Semenov
Registered author(s):

    Abstract

    This paper investigates the role of consumer heterogeneity in explaining asset returns. Using a Taylor series expansion of the individual's marginal utility of consumption around the conditional expectation of consumption, we derive an approximate equilibrium model for expected returns. In this model, the priced risk factors are the cross-moments of return with the moments of the cross-sectional distribution of individual consumption and the signs of the risk factor coefficients are driven by preference assumptions. That allows to avoid an ad hoc specification of preferences and to consider a general class of utility functions when addressing the question of the effect of a particular cross-sectional moment of individual consumption on the expected equity premium and risk-free rate. We demonstrate that if consumers exhibit decreasing and convex absolute prudence, then the cross-sectional mean and skewness of individual consumption yield a higher equity premium if their cross-moments with the excess market portfolio return are positive, while the cross-sectional variance and kurtosis always lower the equity premium explained by the model. Using data from the U.S. Consumer Expenditure Survey, we find that, in contrast to the complete consumption insurance case, the model with heterogeneous consumers reproduces the observed equity premium and risk-free rate with economically plausible values of the relative risk aversion coefficient (between 0.6 and 1.6) and the time discount factor when the cross-sectional skewness of individual consumption, combined with the cross-sectional mean and variance, is taken into account

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://dept.econ.yorku.ca/~asemenov/wp2003-12-1.pdf
    File Function: main text
    Download Restriction: no

    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 334.

    as in new window
    Length:
    Date of creation: 2004
    Date of revision:
    Handle: RePEc:red:sed004:334

    Contact details of provider:
    Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
    Fax: 1-314-444-8731
    Email:
    Web page: http://www.EconomicDynamics.org/society.htm
    More information through EDIRC

    Related research

    Keywords: equity premium puzzle; heterogeneous consumers; incomplete consumption insurance; limited asset market participation; risk-free rate puzzle;

    Find related papers by JEL classification:

    This paper has been announced in the following NEP Reports:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Orazio P. Attanasio & Guglielmo Weber, 1994. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," NBER Working Papers 4795, National Bureau of Economic Research, Inc.
    2. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
    3. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
    4. Mankiw, N. Gregory, 1986. "The equity premium and the concentration of aggregate shocks," Journal of Financial Economics, Elsevier, vol. 17(1), pages 211-219, September.
    5. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August.
    6. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
    7. John Y. Campbell & N. Gregory Mankiw, 1991. "Permanent Income, Current Income, and Consumption," NBER Working Papers 2436, National Bureau of Economic Research, Inc.
    8. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
    9. Alon Brav & George M. Constantinides & Christopher C. Geczy, 1999. "Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence," NBER Working Papers 7406, National Bureau of Economic Research, Inc.
    10. Ray Chou & Robert F. Engle & Alex Kane, 1991. "Measuring Risk Aversion From Excess Returns on a Stock Index," NBER Working Papers 3643, National Bureau of Economic Research, Inc.
    11. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
    12. Stephen Gordon & Pascal St-Amour, 2003. "Asset Returns and State-Dependent Risk Preferences," CIRANO Working Papers 2003s-09, CIRANO.
    13. Stephen P. Zeldes, . "Consumption and Liquidity Constraints: An Empirical Investigation," Rodney L. White Center for Financial Research Working Papers 16-88, Wharton School Rodney L. White Center for Financial Research.
    14. Andrew B. Abel, 1998. "Risk Premia and Term Premia in General Equilibrium," NBER Working Papers 6683, National Bureau of Economic Research, Inc.
    15. Runkle, David E., 1991. "Liquidity constraints and the permanent-income hypothesis : Evidence from panel data," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 73-98, February.
    16. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
    17. 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, vol. 99(2), pages 263-86, April.
    18. Kris Jacobs, 1999. "Incomplete Markets and Security Prices: Do Asset-Pricing Puzzles Result from Aggregation Problems?," Journal of Finance, American Finance Association, vol. 54(1), pages 123-163, 02.
    19. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-62, April.
    20. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    21. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
    22. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    23. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," NBER Working Papers 8896, National Bureau of Economic Research, Inc.
    24. Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-57, March.
    25. Aschauer, David Alan, 1985. "Fiscal Policy and Aggregate Demand," American Economic Review, American Economic Association, vol. 75(1), pages 117-27, March.
    26. Basak, Suleyman & Cuoco, Domenico, 1998. "An Equilibrium Model with Restricted Stock Market Participation," Review of Financial Studies, Society for Financial Studies, vol. 11(2), pages 309-41.
    27. Eichenbaum, Martin S & Hansen, Lars Peter & Singleton, Kenneth J, 1988. "A Time Series Analysis of Representative Agent Models of Consumption and Leisure Choice under Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 103(1), pages 51-78, February.
    28. McCurdy, Thomas H & Morgan, Ieuan G, 1991. "Tests for a Systematic Risk Component in Deviations from Uncovered Interest Rate Parity," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 587-602, May.
    29. Cogley, Timothy, 2002. "Idiosyncratic risk and the equity premium: evidence from the consumer expenditure survey," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 309-334, March.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as in new window

    Cited by:
    1. Kocherlakota, Narayana & Pistaferri, Luigi, 2005. "Asset Pricing Implications of Pareto Optimality with Private Information," CEPR Discussion Papers 4930, C.E.P.R. Discussion Papers.
    2. Basu, Parantap & Semenov, Andrei & Wada, Kenji, 2009. "Uninsurable Risk and Financial Market Puzzles," MPRA Paper 23351, University Library of Munich, Germany.
    3. Basu, Parantap & Semenov, Andrei & Wada, Kenji, 2011. "Uninsurable risk and financial market puzzles," Journal of International Money and Finance, Elsevier, vol. 30(6), pages 1055-1089, October.

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:red:sed004:334. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.