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Working Paper Abstract

"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 that
the well-known asset pricing puzzles generated by the difficulties of
matching fluctuations in asset prices with high frequency fluctuations
in consumption might be solved found by considering consumption in
the long-run. A first strand of the literature concentrates on multiperiod
differences in log consumption, a second concentrates on the
cointegrating relation for consumption. Interestingly, only the (multiperiod)
Euler Equation for the consumer optimization problem is
considered by the first strand of the literature, while the cointegrationbased
literature concentrates exclusively on the (linearized) intertemporal
budget constraint. In this paper, we show that using the first
order condition in the linearized budget constraint to derive an explicit
long-run consumption function delivers an even more striking
strike back.

JEL Classification Numbers: E2, E44, G12

Keywords: Cointegrating Consumption function, lon-run stock market
returns, elasticity of intertemporal substitution.

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Last updated February 27, 2007