Fat Tails and Spurious Estimation of Consumption-Based Asset Pricing Models

Alexis Akira Toda and Kieran James Walsh

MPRA Paper from University Library of Munich, Germany

Abstract: The standard generalized method of moments (GMM) estimation of Euler equations in heterogeneous-agent consumption-based asset pricing models is inconsistent under fat tails because the GMM criterion is asymptotically random. To illustrate this, we generate asset returns and consumption data from an incomplete-market dynamic general equilibrium model that is analytically solvable and exhibits power laws in consumption. Monte Carlo experiments suggest that the standard GMM estimation is inconsistent and susceptible to Type II errors (incorrect non-rejection of false models). Estimating an overidentified model by dividing agents into age cohorts appears to mitigate Type I and II errors.

Keywords: consumption-based CAPM; generalized method of moments; heterogeneous-agent model; power law (search for similar items in EconPapers)
JEL-codes: C58 D31 D52 D58 G12 (search for similar items in EconPapers)
Date: 2016-11-17
New Economics Papers: this item is included in nep-ore
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Related works:
Journal Article: Fat tails and spurious estimation of consumption‐based asset pricing models (2017)
Working Paper: Fat tails and spurious estimation of consumption-based asset pricing models (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:78980

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