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Consumption Commitments and Asset Prices

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  • Adam Szeidl
  • Raj Chetty

Abstract

This paper studies portfolio choice and asset prices in a model with two consumption goods, one of which involves a commitment in that its consumption can only be adjusted at a cost. Commitments effectively make investors more risk averse: they invest less in risky assets and smooth total consumption more. Aggregating over a population of such consumers implies dynamics that match those of a representative consumer economy with habit formation. Calibrations show that the model can resolve the equity premium puzzle. We test the key prediction that an exogenous increase in economic commitments (e.g., housing) causes a more conservative portfolio allocation using a novel instrumental variables strategy related to age at marriage. We find that a $1 increase in housing causes a 50-70 cent reallocation from stocks to bonds for the average investor. Exploiting differences in the variance of home prices across cities, we show that this effect is due to commitments and not greater exposure to housing price risk.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 354.

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Date of creation: 2004
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Handle: RePEc:red:sed004:354

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Related research

Keywords: habit formation; portfolio choice; housing;

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