Working Paper: NBER ID: w7406
Authors: Alon Brav; George M. Constantinides; Christopher C. Geczy
Abstract: The Euler equations of consumption are tested on the household consumption of non-durables and services, reconstructed from the CEX database. The estimated relative risk aversion coefficient of the representative household decreases, and the estimated unexplained mean equity premium decreases, as infra marginal asset holders are eliminated from the sample. These results provide evidence of limited capital market participation. The estimated unexplained mean equity premium decreases when the assumption of complete consumption insurance is relaxed. The estimated correlation between the equity premium and the cross- sectional variance of the households' consumption growth is negative, as required, if the relaxation of market completeness is to contribute towards the explanation of the premium. The overall evidence from asset prices in favor of relaxing the assumption of complete consumption insurance is weak. An extensive Monte Carlo investigation highlights the relationship between the economic implications of limited participation and the resulting statistical properties of commonly used test statistics. The simulation results provide direct evidence relating observation error in consumption and the resulting small-sample of the test statistics.
Keywords: No keywords provided
JEL Codes: G12; D91; E21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Exclusion of infra marginal asset holders (G33) | Decrease in estimated relative risk aversion coefficient (D11) |
| Exclusion of infra marginal asset holders (G33) | Decrease in unexplained mean equity premium (G19) |
| Relaxation of complete consumption insurance (G52) | Decrease in estimated unexplained mean equity premium (G19) |
| Negative correlation between equity premium and cross-sectional variance of household consumption growth (D15) | Contribution to explaining the equity premium (G19) |