The 6D Bias and the Equity Premium Puzzle

Xavier Gabaix and David Laibson

No 1947, Harvard Institute of Economic Research Working Papers from Harvard - Institute of Economic Research

Abstract: If decision costs lead agents to update consumption every D periods, then econometricians will find an anomalously low correlation between equity returns and consumption growth (Lynch 1996). We analytically characterize the dynamic properties of an economy composed of consumers who have such delayed updating. In our setting, an econometrician using an Euler equation procedure would infer a coefficient of relative risk aversion biased up by a factor of 6D. Hence with quarterly data, if agents adjust their consumption every D = 4 quarters, the imputed coefficient of relative risk aversion will be 24 times greater than the true value. High levels of risk aversion implied by the equity premium and violations of the Hansen-Jagannathan bounds cease to be puzzles. The neoclassical model with delayed adjustment explains the consumption behavior of shareholders. Once limited participation is taken into account, the model matches most properties of aggregate consumption and equity returns, including new evidence that the covariance between ln(Ct+h/Ct) and Rt+1 slowly rises with h.

Date: 2002
References: Add references at CitEc
Citations: View citations in EconPapers (125)

Downloads: (external link)
http://www.economics.harvard.edu/pub/hier/2002/HIER1947.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://www.economics.harvard.edu/pub/hier/2002/HIER1947.pdf [301 Moved Permanently]--> https://www.economics.harvard.edu/pub/hier/2002/HIER1947.pdf)

Related works:
Chapter: The 6D Bias and the Equity-Premium Puzzle (2002)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fth:harver:1947

Access Statistics for this paper

More papers in Harvard Institute of Economic Research Working Papers from Harvard - Institute of Economic Research Contact information at EDIRC.
Bibliographic data for series maintained by Thomas Krichel ().