The Double Power Law in Consumption and Implications for Testing Euler Equations

21 Pages Posted: 2 Sep 2013 Last revised: 29 Oct 2015

See all articles by Alexis Akira Toda

Alexis Akira Toda

University of California, San Diego (UCSD) - Department of Economics

Kieran James Walsh

University of California, Santa Barbara (UCSB) - Department of Economics

Date Written: September 1, 2014

Abstract

We provide evidence suggesting that the cross-sectional distributions of U.S. consumption and its growth rate obey the power law in both the upper and lower tails, with exponents approximately equal to 4. Consequently, high order moments are unlikely to exist, and the GMM estimation of Euler equations that employs cross-sectional moments may be inconsistent. Through bootstrap studies, we find that the power law appears to generate spurious non-rejection of heterogeneous-agent asset pricing models in explaining the equity premium. Dividing households into age groups, we propose an estimation approach which appears less susceptible to fat tail issues.

Suggested Citation

Toda, Alexis Akira and Walsh, Kieran James, The Double Power Law in Consumption and Implications for Testing Euler Equations (September 1, 2014). Journal of Political Economy, Vol. 123, No. 5, pp. 1177-1200, 2015, Available at SSRN: https://ssrn.com/abstract=2319454 or http://dx.doi.org/10.2139/ssrn.2319454

Alexis Akira Toda (Contact Author)

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
Mail Code 0508
La Jolla, CA 92093-0508
United States

HOME PAGE: http://https://sites.google.com/site/aatoda111/

Kieran James Walsh

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

Santa Barbara, CA

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