Asset Pricing with Durable Goods and Nonhomothetic Preferences

Abstract

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-minusgrowth 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 explaining the cross section of average returns of the 25 Fama-French portfolios. The model features a novel non-diversifiable 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. * Office of Doctoral Studies, Graduate School of Business, University of Chicago. I have benefitted from helpful comments of

Oil Prices and Long-Run Risk

“…This is an important point of differentiation between my model and the models of Pakos [2004], Yogo [2006], and Yang [2010], which rely on the degree of substitution between durable and nondurable consumption to generate asset pricing implications. The results in this model are driven by the growth rate dynamics of c t and o t , and the function V t is merely a means to obtain the expression for the oil price in terms of consumption.…”

Durability of Output and Expected Stock Returns

“…Homothetic preferences suffice for our analysis because the volatility of nondurable and service consumption is similar to that of the stock of durables (i.e., the sum of consumer durable goods and private residential fixed assets) at our level of aggregation. Bils and Klenow (1998) and Pakoš (2004) analyze a model with nonhomothetic preferences for more disaggregated categories of consumption, where the evidence for nonhomotheticity seems stronger. standard choices in macroeconomics.…”

Intertemporal preference parameters for some European monetary union countries

“…2 On the other hand, the omission of durable consumption in the estimation of preference parameters, a common practice which may not be appropriate insofar as preferences which are intratemporally inseparable could introduce a downwards bias into the estimates of intertemporal elasticity of substitution. This is the fundamental reason pointed out by Ogaki and Reinhart (1998a, b) to explain abnormally low estimates of intertemporal elasticity of substitution, and the same line is followed by Dunn and Singleton (1986), Eichenbaum and Hansen (1990) , Lo´pez Salido (1993), Mamaysky (2001), Okubo (2002), Pakos (2004), Wirjanto (2004), Ma´rquez de la Cruz (2005) and Yogo (2006). 3 Our research is therefore based on the hypothesis of the impact that durable consumption might have on the estimation of certain preference parameters in the context of the CCAPM model.…”