Asset pricing without garbage
This paper provides an explanation why garbage as a measure of consumption implies a several times lower coefficient of relative risk aversion in the consumption-based asset pricing model than consumption based on the official National Income and Product Accounts (NIPA): Unlike garbage, NIPA consumption is filtered to mitigate measurement error. I apply a structural model of the filtering process, which allows to revoke the filter inherent in NIPA consumption. Unfiltered NIPA consumption performs as well as garbage in explaining the equity premium and risk-free rate puzzle. Furthermore, I find that two other popular NIPA-based measures, three-year and fourth-quarter NIPA consumption, are related to unfiltered NIPA consumption. Both can be viewed as ad hoc unfilter rules.
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- Alexi Savov, 2011. "Asset Pricing with Garbage," Journal of Finance, American Finance Association, vol. 66(1), pages 177-201, 02.
- Daniel C. Quan & John M. Quigley, 1989. "Inferring an Investment Return Series for Real Estate from Observations on Sales," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 17(2), pages 218-230.
- Gregory, Allan W. & Wirjanto, Tony, 1993. "The effect of sampling error on the time series behavior of consumption data," Journal of Econometrics, Elsevier, vol. 55(1-2), pages 267-273.
- Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
- Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
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