Consumption Commitments and Asset Prices
This paper studies portfolio choice and asset prices in a model with two consumption goods, one of which involves a commitment in that its consumption can only be adjusted at a cost. Commitments effectively make investors more risk averse: they invest less in risky assets and smooth total consumption more. Aggregating over a population of such consumers implies dynamics that match those of a representative consumer economy with habit formation. Calibrations show that the model can resolve the equity premium puzzle. We test the key prediction that an exogenous increase in economic commitments (e.g., housing) causes a more conservative portfolio allocation using a novel instrumental variables strategy related to age at marriage. We find that a $1 increase in housing causes a 50-70 cent reallocation from stocks to bonds for the average investor. Exploiting differences in the variance of home prices across cities, we show that this effect is due to commitments and not greater exposure to housing price risk.
|Date of creation:||2004|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
Web page: http://www.EconomicDynamics.org/
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:red:sed004:354. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann)
If references are entirely missing, you can add them using this form.