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The Return to Wealth, Asset Pricing, and the Intertemporal Elasticity of Substitution

Author

Listed:
  • Thomas D. Tallarini

    (Jr., Federal Reserve Board)

  • Amir Yaron

    (Univ. of Pennsylvania (Wharton))

  • Ravi Bansal

    (Duke University (Fuqua))

Abstract

We estimate a consumption-based asset pricing model with Epstein-Zin (1989) preferences. The intertemporal marginal rate of substitution (IMRS) depends on the return on total wealth. Rather than use the stock market as a proxy for wealth, we construct a more comprehensive return: we include the value of corporate equity and debt, durable goods (houses), and human capital. Our measure of human capital and its return is estimated jointly with the preference parameters. Our preliminary results are: the intertemporal elasticity of substitution is greater than one, the IMRS satisfies the Hansen-Jagannathan (1991) bound, and human capital comprises about 85 percent of total wealth, its return is about 6 percent per year (about 2 percentage points lower than equities) and has a Sharpe ratio that is about double that of equities.

Suggested Citation

  • Thomas D. Tallarini & Amir Yaron & Ravi Bansal, 2008. "The Return to Wealth, Asset Pricing, and the Intertemporal Elasticity of Substitution," 2008 Meeting Papers 918, Society for Economic Dynamics.
  • Handle: RePEc:red:sed008:918
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    References listed on IDEAS

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    1. Jagannathan, Ravi & Wang, Zhenyu, 1996. " The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March.
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    3. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, vol. 59(4), pages 1481-1509, August.
    4. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, August.
    5. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    6. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
    7. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-357, April.
    8. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-286, April.
    9. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-969, July.
    10. Hansen, Lars Peter & Heaton, John & Yaron, Amir, 1996. "Finite-Sample Properties of Some Alternative GMM Estimators," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(3), pages 262-280, July.
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