Working Paper Abstract
291."Consumption, Wealth, the Elasticity of Intertemporal Substitution and Long-Run Stock Market Returns"by Carlo A. Favero (IGIER, UniversitÓ Bocconi and CEPR)
Consumption is striking back. Some recent evidence indicates thatthe well-known asset pricing puzzles generated by the difficulties ofmatching fluctuations in asset prices with high frequency fluctuationsin consumption might be solved found by considering consumption inthe long-run. A first strand of the literature concentrates on multiperioddifferences in log consumption, a second concentrates on thecointegrating relation for consumption. Interestingly, only the (multiperiod)Euler Equation for the consumer optimization problem isconsidered by the first strand of the literature, while the cointegrationbasedliterature concentrates exclusively on the (linearized) intertemporalbudget constraint. In this paper, we show that using the firstorder condition in the linearized budget constraint to derive an explicitlong-run consumption function delivers an even more strikingstrike back.
JEL Classification Numbers: E2, E44, G12Keywords: Cointegrating Consumption function, lon-run stock marketreturns, elasticity of intertemporal substitution.
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