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Asset Pricing with Idiosyncratic Consumption Risk and Limited Participation

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  • Andrei Semenov

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    (Department of Economics, York University)

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    Abstract

    A growing body of literature suggests limited asset market participation as a plausible explanation of the empirical failure of the standard consumption capital asset pricing model (CCAPM). Correct identification of capital markets investors is, however, often impossible due to imperfection of available information on assetholding status. As a plausible solution to the problem of sample classification when available information is an imperfect sample separation indicator, we propose the CCAPM in which the pricing kernel is calculated as the weighted average of individual households¡¯ marginal rate of substitution, with the weights being the probabilities of holding the asset in question. The asset holding probabilities are conditional on available sample separation information and estimated from a binary response model as a function of demographic and family characteristics of consumers simultaneously with the parameters of Euler equations. The CCAPM with probability-weighted agents is less susceptible to sample misclassification compared to when available imperfect information on asset holding status is used to separate assetholders from nonassetholders. Using data from the U.S. Consumer Expenditure Survey (CEX), we find that, in contrast to when the reported in the CEX financial information is regarded as a perfect sample separation indicator, the model with probability-weighted agents is not rejected statistically both under conventional normal and weak-identification asymptotics and yields precise and economically realistic estimates of the coefficient of relative risk aversion (RRA). The hypothesis that the households¡¯ market participation behavior exhibits considerable persistence is not rejected statistically. Empirical evidence is that the decision to own assets is likely to be endogenous with respect to the consumption and savings decisions and that allowing for this fact is important for estimating risk aversion.

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    File URL: http://econ.yorku.ca/%7Easemenov/wp2004-1-1.pdf
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    Bibliographic Info

    Paper provided by York University, Department of Economics in its series Working Papers with number 2004_1.

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    Length: 38 pages
    Date of creation: Apr 2004
    Date of revision:
    Handle: RePEc:yca:wpaper:2004_1

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    Related research

    Keywords: equity premium puzzle; Euler equation; limited asset market participation; probit model; risk-free rate puzzle;

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    References

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    7. Garcia, Rene & Lusardi, Annamaria & Ng, Serena, 1997. "Excess Sensitivity and Asymmetries in Consumption: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(2), pages 154-76, May.
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    15. Avery, Robert B & Hansen, Lars Peter & Hotz, V Joseph, 1983. "Multiperiod Probit Models and Orthogonality Condition Estimation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 24(1), pages 21-35, February.
    16. Fuhrer, Jeffrey C. & Moore, George R. & Schuh, Scott D., 1995. "Estimating the linear-quadratic inventory model Maximum likelihood versus generalized method of moments," Journal of Monetary Economics, Elsevier, vol. 35(1), pages 115-157, February.
    17. Philippe Weil, 1989. "The Equity Premium Puzzle and the Riskfree Rate Puzzle," NBER Working Papers 2829, National Bureau of Economic Research, Inc.
    18. 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.
    19. Hansen, Lars Peter & Heaton, John & Yaron, Amir, 1996. "Finite-Sample Properties of Some Alternative GMM Estimators," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(3), pages 262-80, July.
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    23. Andrei Semenov, 2004. "High-Order Consumption Moments and Asset Pricing," Econometric Society 2004 North American Winter Meetings 130, Econometric Society.
    24. James H. Stock & Jonathan Wright, 2000. "GMM with Weak Identification," Econometrica, Econometric Society, vol. 68(5), pages 1055-1096, September.
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