Measuring Intratemporal and Intertemporal Substitutions When Both Income and Substitution Effects Are Present: The Role of Consumer Durables

Hall (1988) estimates the intertemporal substitutability for nondurable goods economically and statistically insignificant. Ogaki and Reinhart (1998) introduce the service flow from durable goods using within-period-nonseparable homothetic preference specification. They estimate the intertemporal substitutability significant - around 0.4, and the intratemporal substitutability greater than one. I show that homotheticity induces a surprisingly dramatic statistical bias in the estimates of the intratemporal and intertemporal substitutions. Using aggregate consumption data, I discover that the estimate of the intertemporal substitutability is economically quite negligible - on the order of 0.04, a magnitude close to Hall’s original estimate. In addition, I estimate the intratemporal substitutability between nondurable goods and service flow from the stock of consumer durable goods economically small as well - around 0.18. In addition, I find potent support in favor of nonhomotheticity, with nondurable goods being necessities and durable goods luxuries. Despite that, due to the secular decline of the rental cost, the budget share of consumer durable goods appears trendless.

Equity Prices Under Bayesian Doubt About Macroeconomic Fundamentals

I present a consumption-based explanation of a number of phenomena in the aggregate equity market. The model invokes the recursive utility function of Epstein and Zin (1989), configured with the plausible parameters of the average coefficient of the aversion to late resolution of uncertainty of about 22, and the elasticity of intertemporal substitution of 1.5. Statistically hard to discriminate in less than 80 years of data from the ubiquitous model of real consumption growth, the endowment process is specified as being subject to sporadic large shocks and incessant small shocks. The large infrequent shocks, modelled by means of a four-state hidden Markov chain, display interesting macroeconomic regularities, occuring at both the business-cycle, and a lower, frequencies. Despite the fact that the levels of endowments are observable, the source of their variation cannot be detected perfectly, facing investors with a complex signal-extraction problem. The associated posterior probabilities provide a natural link between the observed asset value fluctuations and the economic uncertainty within the rational Bayesian learning framework. Although computationally arduous, having to be solved on a high-performance computing machine in a low-level language, the model is able to account for (i) the observed magnitude of the equity premium, (ii) the low and stable risk-free rate, (iii) the magnitude and the countercyclicality of risk prices, (iv) the average levels and the procyclicality of price-dividend and wealth-consumption ratios, (v) the long-horizon predictability of risk premia, and (vi) the overreaction of price-dividend ratio to bad news in good times, all within the conceptually simple representative-agent framework.

Estimating intertemporal and intratemporal substitutions when both income and substitution effects are present: the role of durable goods

Homotheticity induces a dramatic statistical bias in the estimates of the intratemporal and intertemporal substitutions. I find potent support in favor of nonhomotheticity in aggregate consumption data, with nondurable goods being necessities and durable goods luxuries. I obtain the intertemporal substitutability negligible (0.04), a magnitude close to Hall’s (1988) original estimate, and the intratemporal substitutability between nondurable goods and service flow from the stock of durable goods small as well (0.18). Despite that, due to the secular decline of the rental cost, the budget share of durable goods appears trendless.consumption, durable goods, nonhomotheticity, elasticity of substitution, asset pricing

Asset Pricing with Home Capital

I analyze a stylized consumption-based asset pricing model that features heterogeneous agents and household capital, and discover a novel recession risk factor related to the cross-sectional second moments of the corresponding investments into such home capital. In order to fully isolate the orthogonal effects at work, I completely shut off the well-known mechanism of Constantinides and Duffie (1996) by explicitly stipulating homoscedastic cross-sectional distribution of nondurable goods and services.

Asset Pricing with Durable Goods and Nonhomothetic Preferences

I present a consumption-based asset pricing model that is capable of matching the empirically observed Sharpe ratios of the aggregate market portfolio as well as the Fama-French value-minus-growth portfolio. The model also matches the level of the risk-free rate and the equity premium with a plausible aversion to wealth bets. In empirical analysis, the model performs well in explain- ing the cross section of average returns of the 25 Fama-French portfolios. The model features a novel non-diversi¯able macroeconomic source of risk: the distortion of the variety of the consumption portfolio. In the model, investors derive utility from two consumption goods - nondurables and durables - which are perfect complements. The novel consumption risk of the stock market stems from the inability to sell durables in recessions in order to restore the optimal variety of the consumption basket.Asset Pricing, Durable Goods, Cross Section of Expected Returns

Long-Run Risk and Hidden Growth Persistence

An extensive literature has analyzed the implications of hidden shifts in the dividend growth rate. However, corresponding research on learning about growth persistence is completely lacking. Hidden persistence is a novel way to introduce long-run risk into standard business-cycle models of asset prices because it tightly intertwines the cyclical and long-run frequencies. Hidden persistence magnifies endogenous changes in the forecast variance of the long-run dividend growth rate despite homoscedastic consumption innovations. Not only does changing forecast variance make discrimination between protracted spells of anemic growth and brief business recessions difficult, it also endogenously induces additional variation in asset price discounts due to the preference for early uncertainty resolution