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On the stability of the wealth effect

Author

Listed:
  • Pedro Bação

    (University of Coimbra and GEMF)

  • Fernando Alexandre

    (Universidade do Minho and NIPE)

  • Vasco J. Gabriel

    (University of Surrey, UK and NIPE)

Abstract

We argue that the equation commonly used in the estimation of the wealth effect on consumption might be unsuitable for that purpose. In particular, if the usual assumptions are employed, the derivation of the equation implies that the wealth effect is indeterminate. Furthermore, it implies that the estimate of the wealth effect should decrease when asset wealth volatility increases. Estimation of a Markov-switching model of the usual long-run aggregate consumption equation provides evidence favourable to the indeterminacy hypothesis

Suggested Citation

  • Pedro Bação & Fernando Alexandre & Vasco J. Gabriel, 2006. "On the stability of the wealth effect," Computing in Economics and Finance 2006 281, Society for Computational Economics.
  • Handle: RePEc:sce:scecfa:281
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    References listed on IDEAS

    as
    1. Martin Lettau & Sydney C. Ludvigson, 2004. "Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption," American Economic Review, American Economic Association, vol. 94(1), pages 276-299, March.
    2. Gabriel Vasco J. & Alexandre Fernando & Bação Pedro, 2008. "The Consumption-Wealth Ratio under Asymmetric Adjustment," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 12(4), pages 1-32, December.
    3. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246, National Bureau of Economic Research, Inc.
    4. Martin Lettau & Sydney Ludvigson, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, June.
    5. Hansen, Bruce E, 2002. "Tests for Parameter Instability in Regressions with I(1) Processes," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 45-59, January.
    6. Sydney Ludvigson & Charles Steindel, 1999. "How important is the stock market effect on consumption?," Economic Policy Review, Federal Reserve Bank of New York, vol. 5(Jul), pages 29-51.
    7. Hall, Stephen G & Psaradakis, Zacharias & Sola, Martin, 1997. "Cointegration and Changes in Regime: The Japanese Consumption Function," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 12(2), pages 151-168, March-Apr.
    8. Carrasco, Marine, 2002. "Misspecified Structural Change, Threshold, and Markov-switching models," Journal of Econometrics, Elsevier, vol. 109(2), pages 239-273, August.
    9. James M. Poterba, 2000. "Stock Market Wealth and Consumption," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 99-118, Spring.
    10. Yash P. Mehra, 2001. "The wealth effect in empirical life-cycle aggregate consumption equations," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 45-67.
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    Cited by:

    1. Blandina Oliveira & Adelino Fortunato, 2008. "The dynamics of the growth of firms: evidence from the services sector," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 35(3), pages 293-312, July.

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    More about this item

    Keywords

    Parameter instability; Markov switching; Consumption; Wealth effect;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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