Consumption-Based Asset Pricing When Consumers Make Mistakes

Christopher Anderson

No 2021-015, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: I analyze the implications of allowing consumers to make mistakes on the risk-return relationships predicted by consumption-based asset pricing models. I allow for consumption mistakes using a model in which a portfolio manager selects investments on a consumer's behalf. The consumer has an arbitrary consumption policy that could reflect a wide range of mistakes. For power utility, expected returns do not generally depend on exposure to single-period consumption shocks, but robustly depend on exposure to both long-run consumption and expected return shocks. I empirically show that separately accounting for both types of shocks helps explain the equity premium and cross section of stock returns.

Keywords: Asset pricing; Consumer mistakes; Consumption-based asset pricing; Intertemporal CAPM; Long-run risks (search for similar items in EconPapers)
JEL-codes: G11 G12 G23 G40 G50 G51 (search for similar items in EconPapers)
Pages: 71 p.
Date: 2021-03-19
New Economics Papers: this item is included in nep-ene, nep-ore and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2021-15

DOI: 10.17016/FEDS.2021.015

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