Working Paper: CEPR ID: DP2503
Authors: Erzo G. J. Luttmer; Thomas Mariotti
Abstract: This paper describes the equilibrium of a discrete-time exchange economy in which consumers with arbitrary subjective discount factors and quasi-homothetic period utility functions follow linear Markov consumption and portfolio strategies. Explicit expressions are given for state prices and consumption-wealth ratios. If utility is logarithmic or endowment growth is i.i.d., then this economy is observationally equivalent to one in which consumers discount geometrically. We provide analytically convenient continuous-time approximations and examine the effects of non-geometric subjective discount factors in an economy in which log endowments are subject to temporary and permanent shocks that are governed by a Feller (1951) square-root process. Hyperbolic and quasi-hyperbolic discount factors can significantly increase the volatility of aggregate wealth and raise the expected excess return on aggregate wealth.
Keywords: asset pricing; consumption-wealth ratios; general equilibrium; hyperbolic discounting; volatility
JEL Codes: D50; D91; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| subjective discount factors (D15) | volatility of aggregate wealth (E21) |
| subjective discount factors (D15) | expected excess return on aggregate wealth (E21) |
| inability of consumers to commit (D10) | strategic decision-making (D70) |
| strategic decision-making (D70) | market outcomes (P42) |
| long-lived assets (D25) | existence of competitive equilibrium (D50) |