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When the Going Gets Tough: Durable Consumption and the Equity Premium

Myroslav Pidkuyko

Centre for Growth and Business Cycle Research Discussion Paper Series from Economics, The University of Manchester

Abstract: I present an endowment economy where a representative agent has recursive preferences over the consumption of non-durable and durable goods, and uncertainty about the underlying endowments. Using parameter calibration consistent with real business cycle literature (risk aversion coefficient of 2.1 and elasticity of intertemporal substitution of 1.09), the model generates a high level of equity premium and a low and stable risk-free rate. The model is also able to explain up to 60% of the equity volatility. The volatile expenditure on durable consumption goods generates a high and volatile equity premium; endogenous time-varying uncertainty produces a counter-cyclical equity premium.

Pages: 34 pages
Date: 2016
New Economics Papers: this item is included in nep-upt
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