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Consumption Commitments and Asset Prices

Author

Listed:
  • Adam Szeidl
  • Raj Chetty

Abstract

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.

Suggested Citation

  • Adam Szeidl & Raj Chetty, 2004. "Consumption Commitments and Asset Prices," 2004 Meeting Papers 354, Society for Economic Dynamics.
  • Handle: RePEc:red:sed004:354
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    File URL: http://kuznets.fas.harvard.edu/~szeidl/papers/commitments.pdf
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    Cited by:

    1. repec:pri:wwseco:dp233 is not listed on IDEAS
    2. Ricardo Reis, 2009. "The Time-Series Properties of Aggregate Consumption: Implications for the Costs of Fluctuations," Journal of the European Economic Association, MIT Press, vol. 7(4), pages 722-753, June.
    3. Raj Chetty, 2004. "Consumption Commitments, Unemployment Durations, and Local Risk Aversion," NBER Working Papers 10211, National Bureau of Economic Research, Inc.
    4. Leung, Charles, 2004. "Macroeconomics and housing: a review of the literature," Journal of Housing Economics, Elsevier, vol. 13(4), pages 249-267, December.
    5. David E. Bloom & David Canning & Michael Moore, 2004. "The Effect of Improvements in Health and Longevity on Optimal Retirement and Saving," NBER Working Papers 10919, National Bureau of Economic Research, Inc.
    6. Andrew Postlewaite & Larry Samuelson & Dan Silverman, 2001. "Consumption Commitments and Preferences for Risk," PIER Working Paper Archive 04-021, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 18 May 2004.
    7. Stephen H. Shore & Todd Sinai, 2010. "Commitment, Risk, and Consumption: Do Birds of a Feather Have Bigger Nests?," The Review of Economics and Statistics, MIT Press, vol. 92(2), pages 408-424, May.
    8. Stephen Cauley & Andrey Pavlov & Eduardo Schwartz, 2007. "Homeownership as a Constraint on Asset Allocation," The Journal of Real Estate Finance and Economics, Springer, vol. 34(3), pages 283-311, April.
    9. Chen, Chien-Liang & Kuan, Chung-Ming & Lin, Chu-Chia, 2007. "Saving and housing of Taiwanese households: New evidence from quantile regression analyses," Journal of Housing Economics, Elsevier, vol. 16(2), pages 102-126, June.
    10. Andrew Postlewaite & Larry Samuelson & Dan Silverman, 2008. "Consumption Commitments and Employment Contracts," Review of Economic Studies, Oxford University Press, vol. 75(2), pages 559-578.
    11. Reis, Ricardo, 2006. "Inattentive consumers," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1761-1800, November.
    12. Raj Chetty, 2004. "Optimal Unemployment Insurance When Income Effects are Large," NBER Working Papers 10500, National Bureau of Economic Research, Inc.
    13. Ravi Jagannathan & Yong Wang, 2005. "Consumption Risk and the Cost of Equity Capital," NBER Working Papers 11026, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    habit formation; portfolio choice; housing;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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