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Asset Pricing with Heterogeneous Consumers: When the Data Has Yet to Meet a Theory It Likes

By Olesya V. Grishchenko and Marco Rossi


We present empirical evidence that uninsurable idiosyncratic consumption risk cannot explain the magnitude of the equity premium. Using Consumer Expenditure Survey data set on household consumption from 1984 to 2002, we examine the cross-sectional distribution of consumption growth and its relation to stock returns. We document that cross-sectional moments of household consumption growth have little covariance with aggregate market returns. Furthermore, we construct representative cohorts based on education, age and income and estimate cohort-based conditional Euler equations. Our model is tested via GMM and rejected when we use both cohort-based measures of intertemporal marginal rate of substitution and tighten the definition of asset holders. Our results support Cogley (2002) who finds that cross-sectional moments of consumption growth are at best weak instruments for explaining the equity premium

Topics: incomplete markets, household consumption data, idiosyncratic consumption risk, Euler equations
Year: 2007
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