Consumption Based Asset Pricing Adjusting for Measurement Error in Consumption
33 Pages Posted: 12 Jun 2016
Date Written: June 7, 2016
This paper presents a modification to the testable Euler equation in the form of an adjustment term due to additive measurement error in consumption data. The error in consumption data has the potential to magnify the equity premium puzzle in a CRRA framework and including the adjustment term leads to a reduction in the estimated risk aversion coefficient. The paper also empirically estimates a ballpark figure for the variance of measurement error and demonstrates a significant resolution of the puzzle by including measurement error in the model.
Keywords: Consumption, Measurement Error, CRRA, Consumption Based Asset Pricing
JEL Classification: E21, E44
Suggested Citation: Suggested Citation