Asset Pricing with Consumption Frictions

43 Pages Posted: 8 Nov 2019 Last revised: 29 Mar 2021

See all articles by Kyoung Jin Choi

Kyoung Jin Choi

University of Calgary - Haskayne School of Business

Junkee Jeon

Kyung Hee University - Department of Applied Mathematics

Hyeng Keun Koo

Ajou University - Department of Business Administration

Date Written: March 29, 2021

Abstract

We study asset pricing with consumption frictions. Frictions in consumption include adjustment costs which prevent a consumer from adjusting consumption freely, due to transaction costs, commitments, search and learning costs, and psychological costs. The stochastic discount factor is determined by a marginal investor's marginal utility of adjustable consumption, and has the same form as that of the external habit model, similarly to the models with stock market non-participation. We next identify a potentially important source of risk for asset pricing: simultaneous adjustments of frictional consumption by a large number of population in the economy, which can have a large impact on interest rates. This risk is present neither in the habit model nor in other models, and provides another reason why governments and central banks are much concerned about households' consumption. However, the risk does not affect the market price of risk. We investigate the long-term behavior of asset prices, and show that equity strips have no excess volatility over zero-coupon bonds in the long run, if the stochastic discount factor admits the Hansen-Scheinkman decomposition with appropriate conditions.

Keywords: Frictional Consumption, Adjustable Consumption, Asset Pricing, Habit Model, Intertemporal Loss Aversion, Hansen-Scheinkman Decomposition

JEL Classification: D11, E21, E32, G10

Suggested Citation

Choi, Kyoung Jin and Jeon, Junkee and Koo, Hyeng Keun, Asset Pricing with Consumption Frictions (March 29, 2021). Available at SSRN: https://ssrn.com/abstract=3475159 or http://dx.doi.org/10.2139/ssrn.3475159

Kyoung Jin Choi

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

HOME PAGE: http://sites.google.com/site/kyoungjinchoiecon/

Junkee Jeon (Contact Author)

Kyung Hee University - Department of Applied Mathematics ( email )

1732 Deogyeong-daero, Giheung-gu,
Yongin, 130-701
Korea, Republic of (South Korea)

Hyeng Keun Koo

Ajou University - Department of Business Administration ( email )

206 Worldcup-ro
Yeongtong-gu
Suwon, 443-749
Korea, Republic of (South Korea)

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