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

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  • Hanno Lustig

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.
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  • Hanno Lustig, "undated". "The Wealth-Consumption Ratio: A Litmus Test for Consumption-based Asset Pricing Models," UCLA Economics Online Papers 420, UCLA Department of Economics.
  • Handle: RePEc:cla:uclaol:420
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    6. 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.
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