Consumption, Government Failure, and Asset Prices

46 Pages Posted: 26 Jun 2018 Last revised: 9 Oct 2019

See all articles by Thiago de Oliveira Souza

Thiago de Oliveira Souza

University of Southern Denmark; Danish Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: October 9, 2019

Abstract

The equity premium-risk-free rate level and predictability puzzles in standard power utility consumption-based asset pricing models disappear once we remove the government-imposed component from the consumption expenditure series. I calibrate this component based on the growth rates of two proxies for government intervention, which I also show to forecast the short- and long-term equity premiums between 1974 (or 1981) and 2017. In summary, investors require large premiums to hold stocks because stocks deliver poor returns when government intervention (failure) increases, systematically reducing individual utility levels. Government failure is likely the key macro-finance variable linking asset prices and economic fluctuations.

Keywords: government failure, equity premium puzzle, intervention, regulation, risk

JEL Classification: G1, E1, H1

Suggested Citation

de Oliveira Souza, Thiago, Consumption, Government Failure, and Asset Prices (October 9, 2019). Available at SSRN: https://ssrn.com/abstract=3194190 or http://dx.doi.org/10.2139/ssrn.3194190

Thiago De Oliveira Souza (Contact Author)

University of Southern Denmark ( email )

Campusvej 55
DK-5230 Odense, 5000
Denmark

Danish Finance Institute ( email )

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