The Role of Heterogeneity in Asset Pricing: The Effect of a Clustering Approach

28 Pages Posted: 17 Feb 2009 Last revised: 15 Nov 2011

See all articles by Olesya V. Grishchenko

Olesya V. Grishchenko

Board of Governors of the Federal Reserve System

Marco Rossi

Texas A&M

Date Written: November 3, 2011


In this paper we use a novel clustering approach to study the role of heterogeneity in asset pricing. We present evidence that the equity premium is consistent with a stochastic discount factor calculated as the average of the household clusters' intertemporal marginal rates of substitution in the 1984-2002 period. The result is driven by the skewness of the cluster-based cross-sectional distribution of consumption growth, but cannot be explained by the cross-sectional variance and mean alone. We find that nine clusters are sufficient to explain an equity premium with relative risk aversion coefficient equal to six. The result is robust to various averaging schemes of cluster-based consumption growth used to construct the stochastic discount factor. Lastly, the analysis reveals that standard approximation schemes of the stochastic discount factor using individual household data produce unreliable results, implying a negative stochastic discount factor.

Keywords: aggregation, incomplete markets, clustering approach, household consumption, idiosyncratic consumption risk, Euler equations

JEL Classification: D12, E21, G10, G12

Suggested Citation

Grishchenko, Olesya V. and Rossi, Marco, The Role of Heterogeneity in Asset Pricing: The Effect of a Clustering Approach (November 3, 2011). Journal of Business and Economic Statistics, Forthcoming. Available at SSRN:

Olesya V. Grishchenko (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-2981 (Phone)

Marco Rossi

Texas A&M ( email )

360S Wehner
College Station, TX 77843-4218
United States

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