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Asset Pricing with and without Garbage: The Overlooked Triple-Hypothesis Problem

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  • Delikouras, Stefanos
  • Korniotis, George

Abstract

Testing consumption-based asset pricing models is a triple hypothesis, which requires selecting the consumption data and examining the assumptions for investor preferences and consumption dynamics. We formalize the triple-hypothesis problem within a GMM framework that relaxes the CRRA assumption, jointly estimates consumption dynamics with Euler equations, and includes the risk-free rate variance as a target moment. We find that consumption measures proposed as alternatives to the BEA consumption (e.g., garbage) do not address the shortcomings of the canonical CRRA model with i.i.d. consumption growth. Instead, a model with BEA consumption, Epstein-Zin preferences, and non-i.i.d. consumption dynamics performs equally well.

Suggested Citation

  • Delikouras, Stefanos & Korniotis, George, 2022. "Asset Pricing with and without Garbage: The Overlooked Triple-Hypothesis Problem," CEPR Discussion Papers 16958, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16958
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    More about this item

    Keywords

    Cross-section of expected returns; Epstein-zin preferences; Risk-free rate; Gmm; Consumption growth;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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