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The role of household debt and delinquency decisions in consumption-based asset pricing

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  • Paulo Rogério Faustino Matos

    (Federal University of Ceará)

Abstract

I incorporate household debt and delinquency decisions into a standard model of lifecycle consumption-saving-investment. I also impose a punishment to the delinquent behavior by assuming that the percentage of endowment available is a linear function of the default decision. Theoretically such additional investor decisions are playing a relevant role in terms of completing markets. In practice, it enables me to derive an extended system of Euler equations which does not alter consumption-based fundamental asset pricing equation. It imposes the pricing kernel to account jointly for two additional first-order conditions. I perform empirical exercises aiming to price equity premium in United States from 1987:1 to 2018:1. I find significant elasticity of intertemporal substitution in consumption of the representative agent ranging from 0.24 to 0.55 and risk aversion from 1.82 to 3.51. This approach is also useful to account for the cross-section behavior of domestic assets. I can also use this framework to draw bounds for the household decisions on loan and delinquency and to propose a new rule of thumb relating preferences parameters and credit variables.

Suggested Citation

  • Paulo Rogério Faustino Matos, 2019. "The role of household debt and delinquency decisions in consumption-based asset pricing," Annals of Finance, Springer, vol. 15(2), pages 179-203, June.
    • Handle: RePEc:kap:annfin:v:15:y:2019:i:2:d:10.1007_s10436-019-00344-1
    DOI: 10.1007/s10436-019-00344-1
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    More about this item

    Keywords

    Household underlying principles; Representative agent; Garnishment of a delinquent household endowment; Asset pricing puzzles; Credit market issues;
    All these keywords.

    JEL classification:

    • C36 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Instrumental Variables (IV) Estimation
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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