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Fat tails and spurious estimation of consumption-based asset pricing models

Listed author(s):
  • Toda, Alexis Akira
  • Walsh, Kieran James

The standard generalized method of moments (GMM) estimation of Euler equations in heterogeneous-agent consumption-based asset pricing models is inconsistent under fat tails because the GMM criterion is asymptotically random. To illustrate this, we generate asset returns and consumption data from an incomplete-market dynamic general equilibrium model that is analytically solvable and exhibits power laws in consumption. Monte Carlo experiments suggest that the standard GMM estimation is inconsistent and susceptible to Type II errors (incorrect non-rejection of false models). Estimating an overidentified model by dividing agents into age cohorts appears to mitigate Type I and II errors.

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Paper provided by Department of Economics, UC San Diego in its series University of California at San Diego, Economics Working Paper Series with number qt8df3x7gw.

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Date of creation: 01 Jan 2017
Handle: RePEc:cdl:ucsdec:qt8df3x7gw
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