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

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: November 8, 2016

Abstract

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

Suggested Citation

Toda, Alexis Akira and Walsh, Kieran James, Fat Tails and Spurious Estimation of Consumption-Based Asset Pricing Models (November 8, 2016). Journal of Applied Econometrics, Vol 32, No 6, pp 1156-1177, 2017, Available at SSRN: https://ssrn.com/abstract=2495151 or http://dx.doi.org/10.2139/ssrn.2495151

Alexis Akira Toda

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 (Contact Author)

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

Santa Barbara, CA

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