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Evaluation asset pricing models with limited commitment using household consumption data

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  • Krueger, Dirk
  • Lustig, Hanno
  • Perri, Fabrizio

Abstract

We evaluate the asset pricing implications of a class of models in which risk sharing is imperfect because of the limited enforcement of intertemporal contracts. Lustig (2004) has shown that in such a model the asset pricing kernel can be written as a simple function of the aggregate consumption growth rate and the growth rate of consumption of the set of households that do not face binding enforcement constraints in that state of the world. These unconstrained households have lower consumption growth rates than constrained households, i.e. they are located in the lower tail of the crosssectional consumption growth distribution. We use household consumption data from the U.S. Consumer Expenditure Survey to estimate the pricing kernel implied by the model and to evaluate its performance in pricing aggregate risk. We employ the same data to construct aggregate consumption and to derive the standard complete markets pricing kernel. We find that the limited enforcement pricing kernel generates a market price of risk that is substantially larger than the standard complete markets asset pricing kernel. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2006/22.

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Date of creation: 2006
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Handle: RePEc:zbw:cfswop:200622

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Related research

Keywords: Limited Commitment; Equity Premium; Stochastic Discount Factor; Household Consumption Data;

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References

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  1. Orazio P. Attanasio & James Banks & Sarah Tanner, 2002. "Asset Holding and Consumption Volatility," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 110(4), pages 771-792, August.
  2. Narayana R. Kocherlakota & Luigi Pistaferri, 2007. "Asset Pricing Implications of Pareto Optimality with Private Information," Levine's Bibliography 321307000000000701, UCLA Department of Economics.
  3. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers, Federal Reserve Bank of Minneapolis 445, Federal Reserve Bank of Minneapolis.
  4. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 163-193.
  5. Cogley, Timothy, 2002. "Idiosyncratic risk and the equity premium: evidence from the consumer expenditure survey," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(2), pages 309-334, March.
  6. Fernando Alvarez & Urban J. Jermann, 1999. "Quantitative asset pricing implications of endogenous solvency constraints," Working Papers 99-5, Federal Reserve Bank of Philadelphia.
  7. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," Working Papers 552, Barcelona Graduate School of Economics.
  8. YiLi Chien & Hanno Lustig, 2010. "The Market Price of Aggregate Risk and the Wealth Distribution," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 23(4), pages 1596-1650, April.
  9. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 110(4), pages 825-853, August.
  10. 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.
  11. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  12. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, Econometric Society, vol. 68(4), pages 775-798, July.
  13. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A, University of Bonn, Germany 381, University of Bonn, Germany.
  14. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 55(4), pages 541-54, October.
  15. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," NBER Working Papers 8896, National Bureau of Economic Research, Inc.
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Cited by:
  1. Pu-yan Nie, 2012. "Maintenance Commitments for Monopolized Goods," Prague Economic Papers, University of Economics, Prague, University of Economics, Prague, vol. 2012(1), pages 18-29.
  2. Emil Iantchev, 2013. "Asset-Pricing Implications of Biologically Based Non-Expected Utility," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(3), pages 497-510, July.
  3. Nie, Pu-yan, 2013. "Duopoly quality commitment," Economic Modelling, Elsevier, Elsevier, vol. 33(C), pages 832-842.
  4. Gaetano Bloise & Pietro Reichlin & Mario Tirelli, 2013. "Fragility of Competitive Equilibrium with Risk of Default," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(2), pages 271-295, April.

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