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The Wealth-Consumption Ratio: A Litmus Test for Consumption-based Asset Pricing Models¤

Author

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  • Hanno Lustig

    () (UCLA and NBER)

  • Stijn Van Nieuwerburg

    () (NYU and NBER)

  • Adrien Verdelhan

    () (Boston University)

Abstract

The volatility of the price-dividend ratio on stocks, the predictability of stock returns, and the lack of predictability in dividend growth are commonly interpreted as evidence of substantial time-variation in risk premia. We construct the wealth-consumption ratio for the U.S., the price-dividend ratio on total wealth. We show that it is at least ¯ve times less volatile than the price-dividend ratio on stocks. The wealth-consumption ratio encodes information about conditional market prices of risk, and hence about asset prices. Matching its properties is a litmus test for consumption-based asset pricing models. Models that match the predictability of equity returns impute too much predictability to total wealth returns and hence too much volatility to the wealth-consumption ratio, because they rely on time variation in the risk premium on total wealth. The smoothness of the wealth-consumption ratio suggests that there may be less time-variation in market prices of risk than commonly inferred from equity prices alone.

Suggested Citation

  • Hanno Lustig & Stijn Van Nieuwerburg & Adrien Verdelhan, 2007. "The Wealth-Consumption Ratio: A Litmus Test for Consumption-based Asset Pricing Models¤," Boston University - Department of Economics - Working Papers Series WP2007-030, Boston University - Department of Economics.
  • Handle: RePEc:bos:wpaper:wp2007-030
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    Cited by:

    1. van Binsbergen, Jules H. & Fernández-Villaverde, Jesús & Koijen, Ralph S.J. & Rubio-Ramírez, Juan, 2012. "The term structure of interest rates in a DSGE model with recursive preferences," Journal of Monetary Economics, Elsevier, vol. 59(7), pages 634-648.
    2. Tiago Cavalcanti & José Tavares, 2016. "The Output Cost of Gender Discrimination: A Model‐based Macroeconomics Estimate," Economic Journal, Royal Economic Society, vol. 126(590), pages 109-134, February.
    3. repec:oup:rasset:v:3:y:2013:i:1:p:1-37. is not listed on IDEAS
    4. Raquel Fernandez, 2007. "Culture as Learning: The Evolution of Female Labor Force Participation over a Century," NBER Working Papers 13373, National Bureau of Economic Research, Inc.
    5. Falato, Antonio, 2009. "Happiness maintenance and asset prices," Journal of Economic Dynamics and Control, Elsevier, vol. 33(6), pages 1247-1262, June.
    6. Alberto Alesina & Andrea Ichino & Loukas Karabarbounis, 2011. "Gender-Based Taxation and the Division of Family Chores," American Economic Journal: Economic Policy, American Economic Association, vol. 3(2), pages 1-40, May.
    7. Xiaohong Chen & Jack Favilukis & Sydney C. Ludvigson, 2013. "An estimation of economic models with recursive preferences," Quantitative Economics, Econometric Society, vol. 4(1), pages 39-83, March.
    8. Ludvigson, Sydney C., 2013. "Advances in Consumption-Based Asset Pricing: Empirical Tests," Handbook of the Economics of Finance, Elsevier.
    9. Ralph S.J. Koijen & Jules H. van Binsbergen & Juan F. Rubio-Ramírez & Jesus Fernandez-Villaverde, 2008. "Likelihood Estimation of DSGE Models with Epstein-Zin Preferences," 2008 Meeting Papers 1099, Society for Economic Dynamics.
    10. Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 645-700.
    11. Fernández, Raquel, 2007. "Culture as Learning: The Evolution of Female Labour Force Participation Over a Century," CEPR Discussion Papers 6451, C.E.P.R. Discussion Papers.
    12. Aono, Kohei & Iwaisako, Tokuo, 2013. "The consumption–wealth ratio, real estate wealth, and the Japanese stock market," Japan and the World Economy, Elsevier, vol. 25, pages 39-51.

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