Working Paper: NBER ID: w8822
Authors: Alon Brav; George M. Constantinides; Christopher C. Geczy
Abstract: We present evidence that the equity premium and the premium of value stocks over growth stocks are explained in the 1982 1996 period with a stochastic discount factor (SDF) calculated as the weighted average of individual households' marginal rate of substitution with low and economically plausible values of the relative risk aversion (RRA) coefficient. Household consumption of non-durables and services is reconstructed from the CEX database. Since the above premia are not explained with a SDF calculated as the per capita marginal rate of substitution with low value of the RRA coefficient, the evidence supports the hypothesis of incomplete consumption insurance. We also present evidence is that a SDF calculated as the per capita marginal rate of substitution is better able to explain the equity premium and does so with a lower value of the RRA coefficient, as the definition of asset holders is tightened to recognize the limited participation of households in the capital market.
Keywords: Asset Pricing; Heterogeneous Consumers; Limited Participation; Equity Premium; Stochastic Discount Factor
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 |
|---|---|
| stochastic discount factor (SDF) (D15) | equity premium (G12) |
| limited market participation (G19) | equity premium (G12) |
| limited market participation (G19) | stochastic discount factor (SDF) (D15) |
| per capita marginal rate of substitution (D11) | equity premium (G12) |
| definition of asset holders (G32) | stochastic discount factor (SDF) (D15) |
| definition of asset holders (G32) | relative risk aversion coefficient (D11) |
| per capita consumption growth (F62) | equity premium (G12) |