Using a simulated method of moments approach, the author evaluates a representative consumer asset pricing model in which the consumer is assumed to have time nonseparable preferences of several forms. Examining the model's implications for several moments of asset returns, he finds evidence for the local substitution of consumption with habit formation occurring over longer periods of time. The interaction between these two effects is important. The author also shows that, when accounting for sampling error, a model with local substitution and long-run habit persistence is consistent with the Hansen and Jagannathan (1991) bounds.

This paper specifies and empirically analyzes a continuous-time, linear-quadratic, representative consumer model wit h time-nonseparable preferences of several forms. Within this framewor k, the author shows how time aggregation and time nonseparabilities in preferences over consumption streams can interact. The behavior of b oth seasonally adjusted and unadjusted consumption data is consistent wi th time-nonseparable preferences if consumption goods are durable and i f individuals develop habit over the flow of services from the good. T he data do not support a version of the model that ignores time nonseparabilities in preferences and focuses solely upon time aggregation.

We examine an economy in which agents cannot write contracts contingent on future labor income. The agents face aggregate uncertainty in the form of dividend and systematic labor income risk, and also idiosyncratic labor income risk, which is calibrated using the PSID. The agents trade in financial securities to buffer their idiosyncratic income shocks, but the extent of trade is limited by borrowing constraints, short-sales constraints, and transactions costs. By simultaneously considering aggregate and idiosyncratic shocks, we decompose the effect of transactions costs on the equity premium into two components. The direct effect occurs because individuals equate the net-of-cost margins. A second, indirect effect occurs because transactions costs result in individual consumption that more closely tracks individual income. In the simulations we find that the direct effect dominates and that the model can produce a sizable equity premium only if transactions costs are large or the assumed quantity of tradable assets is limited.

[In this article we provide econometric tools for the evaluation of intertemporal asset pricing models using specification-error and volatility bounds. We formulate analog estimators of these bounds, give conditions for consistency, and derive the limiting distribution of these estimators. The analysis incorporates market frictions such as short-sale constraints and proportional transactions costs. Among several applications we show how to use the methods to assess specific asset pricing models and to provide nonparametric characterizations of asset pricing anomalies.]

Using cross‐sectional data from the SCF and Tax Model, we show that entrepreneurial income risk has a significant influence on portfolio choice and asset prices. We find that households with high and variable business income hold less wealth in stocks than other similarly wealthy households, although they constitute a significant fraction of the stockholding population. Similarly for nonentrepreneurs, holding stock in the firm where one works reduces the portfolio share of other common stocks. Finally, we show that adding proprietary income to a linear asset pricing model improves its performance over a similar model that includes only wage income.

The authors examine an economy with aggregate and idiosyncratic income risk in which agents cannot contract on future labor income. Agents trade financial securities to buffer idiosyncratic shocks but the extent of trade is limited by borrowing constraints and transactions costs. The effect of frictions on the equity premium is decomposed into two components: a direct effect due to the equation of net-of-costs margins and an indirect effect due to increased consumption volatility. Simulations suggest that the direct effect dominates and that the model predicts a sizable equity premium only if costs are large or the quantity of tradable assets is limited.

A significant amount of research by financial economists over the last few decades has attempted to understand various anomalous or puzzling empirical observations taken from financial markets.1 These range from the equity premium puzzle at the aggregate level [see, e.g., Grossman and Shiller (1982) and Mehra and Prescott (1985)], to the small-firm effect [see, e.g., Banz (1981) and Fama and French (1992)], to momentum in returns [see, e.g., De Bondt and Thaler (1985) and Jegadeesh and Titman (1993)], to postevent abnormal returns [see, e.g., Latane and Jones (1977) and Ritter (1991)] at the level of individual stock and portfolio returns. In each case these empirical puzzles are identified by finding portfolios with average returns that are high relative to their risk as measured by the covariance of the returns with the market portfolio, as in the capital asset pricing model (CAPM), or with aggregate consumption, as in the consumption-based CAPM. If the assumptions about market structure and the behavior of agents justifying the models are correct, then return observations imply that agents should trade to take advantage of the observed patterns in returns. There have been three types of explanations put forward for why agents don’t take advantage of the anomalies.

In this article we provide econometric tools for the evaluation of intertemporal asset pricing models using specification-error and volatility bounds. We formulate analog estimators of these bounds, give conditions for consistency, and derive the limiting distribution of these estimators. The analysis incorporates market frictions such as short-sale constraints and proportional transactions costs. Among several applications we show how to use the methods to assess specific asset pricing models and to provide non-parametric characterizations of asset pricing anomalies.

We characterize and measure a long-term risk-return trade-off for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This trade-off features risk prices of cash flows that are realized far into the future but continue to be reflected in asset values. We apply this analysis to claims on aggregate cash flows and to cash flows from value and growth portfolios by imputing values to the long-run dynamic responses of cash flows to macroeconomic shocks. We explore the sensitivity of our results to features of the economic valuation model and of the model cash flow dynamics.