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The Return to Wealth, Asset Pricing, and the Intertemporal Elasticity of Substitution

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Author Info

  • Thomas D. Tallarini

    (Jr., Federal Reserve Board)

  • Amir Yaron

    (Univ. of Pennsylvania (Wharton))

  • Ravi Bansal

    (Duke University (Fuqua))

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    Abstract

    We estimate a consumption-based asset pricing model with Epstein-Zin (1989) preferences. The intertemporal marginal rate of substitution (IMRS) depends on the return on total wealth. Rather than use the stock market as a proxy for wealth, we construct a more comprehensive return: we include the value of corporate equity and debt, durable goods (houses), and human capital. Our measure of human capital and its return is estimated jointly with the preference parameters. Our preliminary results are: the intertemporal elasticity of substitution is greater than one, the IMRS satisfies the Hansen-Jagannathan (1991) bound, and human capital comprises about 85 percent of total wealth, its return is about 6 percent per year (about 2 percentage points lower than equities) and has a Sharpe ratio that is about double that of equities.

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    File URL: http://www.economicdynamics.org/meetpapers/2008/paper_918.pdf
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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 918.

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    Date of creation: 2008
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    Handle: RePEc:red:sed008:918

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    References

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    1. Morris A. Davis & Jonathan Heathcote, 2004. "The price and quantity of residential land in the United States," Finance and Economics Discussion Series 2004-37, Board of Governors of the Federal Reserve System (U.S.).
    2. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report 208, Federal Reserve Bank of Minneapolis.
    3. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    4. Ravi Bansal & Amir Yaron, 2000. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," NBER Working Papers 8059, National Bureau of Economic Research, Inc.
    5. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
    6. 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.
    7. Robert E. Hall, 1981. "Intertemporal Substitution in Consumption," NBER Working Papers 0720, National Bureau of Economic Research, Inc.
    8. Whelan, Karl, 2002. "A Guide to U.S. Chain Aggregated NIPA Data," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 48(2), pages 217-33, June.
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    Cited by:
    1. Na Guo & Peter N. Smith, 2012. "Durable Consumption, Long-Run Risk and The Equity Premium," Discussion Papers 12/37, Department of Economics, University of York.

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