Can Costs of Consumption Adjustment Explain Asset Pricing Puzzles?

We investigate Grossman and Laroque's (1990) conjecture that costs of adjusting consumption can account, in part, for the empirical failure of the consumption-based capital asset pricing model (CCAPM). We incorporate small fixed costs of consumption adjustment into a CCAPM with heterogeneous ag...

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Bibliographic Details
Published in:The Journal of finance (New York) 1999-04, Vol.54 (2), p.623-654
Main Authors: Marshall, David A., Parekh, Nayan G.
Format: Article
Language:English
Subjects:
Aggregate analysis
Asset pricing
Capital assets
CAPM
Consumer economics
Consumer information
Consumption
Consumption theories
Cost of equity
Costs
Economic models
Equity
Financial analysis
Fixed costs
Price level changes
Standard deviation
Statistical variance
Studies
Transfer pricing
Variance analysis
Wealth
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Summary:We investigate Grossman and Laroque's (1990) conjecture that costs of adjusting consumption can account, in part, for the empirical failure of the consumption-based capital asset pricing model (CCAPM). We incorporate small fixed costs of consumption adjustment into a CCAPM with heterogeneous agents. We find that undetectably small consumption adjustment costs can account for much of the discrepancy between the observed variance of nondurable aggregate consumption growth and the predictions of the CCAPM, and can partially reconcile nondurable consumption data with the observed equity premium. We conclude that the CCAPM's implications are nonrobust to extremely small adjustment costs.
ISSN:0022-1082
1540-6261
DOI:10.1111/0022-1082.00119