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When the Going Gets Tough: Durable Consumption and the Equity Premium

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  • Myroslav Pidkuyko

Abstract

I present an endowment economy where a representative agent has recursive preferences over the consumption of non-durable and durable goods, and uncertainty about the underlying endowments. Using parameter calibration consistent with real business cycle literature (risk aversion coefficient of 2.1 and elasticity of intertemporal substitution of 1.09), the model generates a high level of equity premium and a low and stable risk-free rate. The model is also able to explain up to 60% of the equity volatility. The volatile expenditure on durable consumption goods generates a high and volatile equity premium; endogenous time-varying uncertainty produces a counter-cyclical equity premium.

Suggested Citation

  • Myroslav Pidkuyko, 2016. "When the Going Gets Tough: Durable Consumption and the Equity Premium," Centre for Growth and Business Cycle Research Discussion Paper Series 225, Economics, The University of Manchester.
    • Handle: RePEc:man:cgbcrp:225
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    File URL: http://hummedia.manchester.ac.uk/schools/soss/cgbcr/discussionpapers/dpcgbcr225.pdf
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