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THE JOURNAL OF FINANCE VOL. LIX, NO. 6 DECEMBER 2004 Luxury Goods and the Equity Premium
 

Summary: THE JOURNAL OF FINANCE VOL. LIX, NO. 6 DECEMBER 2004
Luxury Goods and the Equity Premium
YACINE AIT-SAHALIA, JONATHAN A. PARKER, and MOTOHIRO YOGO
ABSTRACT
This paper evaluates the equity premium using novel data on the consumption of
luxury goods. Specifying utility as a nonhomothetic function of both luxury and basic
consumption goods, we derive pricing equations and evaluate the risk of holding eq-
uity. Household survey and national accounts data mostly reflect basic consumption,
and therefore overstate the risk aversion necessary to match the observed equity pre-
mium. The risk aversion implied by the consumption of luxury goods is more than
an order of magnitude less than that implied by national accounts data. For the very
rich, the equity premium is much less of a puzzle.
AS DEMONSTRATED BY GROSSMAN AND SHILLER (1981), SHILLER (1982), Mehra and
Prescott (1985), and the extensive literature that follows, the risk of the stock
market as measured by its co-movement with aggregate consumption is in-
sufficient to justify the extent to which its average return exceeds the return
on short-term government debt. We propose a partial resolution to this equity
premium puzzle by distinguishing between the consumption of basic goods and
that of luxury goods. Intuitively, rich households that hold most equity are al-
most satiated in their consumption of basic goods; wealth shocks are reflected

  

Source: At-Sahalia, Yacine - Program in Applied and Comptutational Mathematics & Department of Economics, Princeton University

 

Collections: Mathematics