Testing Heterogeneous-Agent Models: An Alternative Aggregation Approach
Boston College - Carroll School of Management
University of Iowa - Henry B. Tippie College of Business
Journal of Monetary Economics, Forthcoming
Starting from the cross-sectional aggregation of marginal utilities, rather than intertemporal marginal rates of substitution, this paper develops a new heterogeneous-agent pricing kernel. A closed-form version of the new kernel depends on changes in the cross-sectional variance of log consumption, rather than the variance of changes in log consumption, as in Constantinides and Duffie (1996). We implement the new kernel on household consumption data from the Consumer Expenditure Survey (CEX). At monthly and quarterly horizons, the new kernel reconciles the premium on U.S. equities with the consumption of asset holders, for reasonable values of relative risk aversion. The new kernel also fares better than kernels based on the aggregation of intertemporal marginal rates of substitution in explaining the cross-sectional variation of risk premia on stocks and bonds. Portfolios mimicking changes in the cross-sectional variance of log consumption for asset holders command significant negative Sharpe ratios.
Number of Pages in PDF File: 54
Keywords: pricing kernel, heterogeneity
JEL Classification: G12
Date posted: November 1, 2006
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