Fat Tails and Spurious Estimation of Consumption-Based Asset Pricing Models

Toda, Alexis Akira and Walsh, Kieran James (2016): Fat Tails and Spurious Estimation of Consumption-Based Asset Pricing Models. Forthcoming in: Journal of Applied Econometrics

Abstract

The standard generalized method of moments (GMM) estimation of Euler equations in heterogeneous-agent consumption-based asset pricing models is inconsistent under fat tails because the GMM criterion is asymptotically random. To illustrate this, we generate asset returns and consumption data from an incomplete-market dynamic general equilibrium model that is analytically solvable and exhibits power laws in consumption. Monte Carlo experiments suggest that the standard GMM estimation is inconsistent and susceptible to Type II errors (incorrect non-rejection of false models). Estimating an overidentified model by dividing agents into age cohorts appears to mitigate Type I and II errors.

• Item Type: MPRA Paper
• Language: English
• Keywords: consumption-based CAPM, generalized method of moments, heterogeneous-agent model, power law
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; D - Microeconomics > D3 - Distribution > D31 - Personal Income, Wealth, and Their Distributions; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D58 - Computable and Other Applied General Equilibrium Models; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates

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