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Consumption Risk, Preference Heterogeneity and Asset Prices

55 Pages Posted: 28 Mar 2011 Last revised: 16 Oct 2014

Giuliano Curatola

Goethe University Frankfurt - Research Center SAFE

Roberto Marfè

University of Torino - Collegio Carlo Alberto

Date Written: September 1, 2012

Abstract

This paper proposes a pure-exchange economy with three key ingredients: habit formation, stochastic moments of aggregate consumption, and a small degree of heterogeneity in risk aversion consistent with empirical data. We obtain closed formulas for many equilibrium quantities, including the moments of stock returns and individual portfolios. The proposed framework explains simultaneously the main features of stock returns – like cyclicality, persistence and predictability – as well as the counter-cyclical dynamics of the trading volume and its correlation with stock returns. In addition, we provide new testable implications concerning the dynamic behavior of the cross-sectional consumption/portfolio distribution over the business cycle.

Notes: An earlier version of this paper was circulated under the title: "Catching up with the Joneses under Preference Heterogeneity: An Exact Solution."

Keywords: equilibrium asset pricing, heterogeneous preferences, external habit, portfolio strategies, closed form expression

JEL Classification: D51, D53, D83, G11, G12

Suggested Citation

Curatola, Giuliano and Marfè, Roberto, Consumption Risk, Preference Heterogeneity and Asset Prices (September 1, 2012). Available at SSRN: https://ssrn.com/abstract=1793747 or http://dx.doi.org/10.2139/ssrn.1793747

Giuliano Curatola

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Roberto Marfè (Contact Author)

University of Torino - Collegio Carlo Alberto ( email )

via Real Collegio 30
Moncalieri, Torino 10024
Italy

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