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Can Costs of Consumption Adjustment Explain Asset Pricing Puzzles?
Author(s) -
Marshall David A.,
Parekh Nayan G.
Publication year - 1999
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/0022-1082.00119
Subject(s) - economics , capital asset pricing model , consumption (sociology) , grossman , consumption based capital asset pricing model , econometrics , equity premium puzzle , aggregate (composite) , asset (computer security) , variance (accounting) , microeconomics , computer science , keynesian economics , materials science , accounting , composite material , social science , computer security , sociology
We investigate Grossman and Laroque's (1990) conjecture that costs of adjusting consumption can account, in part, for the empirical failure of the consumption‐based capital asset pricing model (CCAPM). We incorporate small fixed costs of consumption adjustment into a CCAPM with heterogeneous agents. We find that undetectably small consumption adjustment costs can account for much of the discrepancy between the observed variance of nondurable aggregate consumption growth and the predictions of the CCAPM, and can partially reconcile nondurable consumption data with the observed equity premium. We conclude that the CCAPM's implications are nonrobust to extremely small adjustment costs.