Fat Tails and Spurious Estimation of Consumption-Based Asset Pricing Models
Journal of Applied Econometrics, Vol 32, No 6, pp 1156-1177, 2017
38 Pages Posted: 13 Sep 2014 Last revised: 6 Nov 2017
Date Written: November 8, 2016
The standard generalized method of moments (GMM) estimation of Euler equations in heterogeneous-agent consumption-based asset pricing models is inconsistent under fat tails because the GMM criterion is asymptotically random. To illustrate this, we generate asset returns and consumption data from an incomplete-market dynamic general equilibrium model that is analytically solvable and exhibits power laws in consumption. Monte Carlo experiments suggest that the standard GMM estimation is inconsistent and susceptible to Type II errors (incorrect non-rejection of false models). Estimating an overidentified model by dividing agents into age cohorts appears to mitigate Type I and II errors.
Keywords: consumption-based CAPM, generalized method of moments, heterogeneous-agent model, power law
JEL Classification: C58, D31, D52, D58, G12
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