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The 6D bias and the equity premium puzzle

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Published by Massachusetts Institute of Technology, Dept. of Economics in Cambridge, MA .
Written in English


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If decision costs lead agents to update consumption every D periods, then econometricians will find an anomalously low correlation between equity returns and consumption growth (Lynch 1996). We analytically characterize the dynamic properties of an economy composed of consumers who have such delayed updating. In our setting, an econometrician using an Euler equation procedure would infer a coefficient of relative risk aversion biased up by a factor of 6D. Hence with quarterly data, if agents adjust their consumption every D = 4 quarters, the imputed coefficient of relative risk aversion will be 24 times greater than the true value. High levels of risk aversion implied by the equity premium and violations of the Hansen-Jagannathan bounds cease to be puzzles. The neoclassical model with delayed adjustment explains the consumption behavior of shareholders. Once limited participation is taken into account, the model matches most properties of aggregate consumption and equity returns, including new evidence that the covariance between lnC(t+h)/lnC(t) and R(t+1) slowly rises with h. Keywords: 6D, bounded rationality, decision costs, delayed adjustment, equity premium puzzle. JEL Classification: E44, G1.

Edition Notes

StatementXavier Gabaix [and] David Laibson
SeriesWorking paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 02-01, Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 02-01.
ContributionsLaibson, David I., Massachusetts Institute of Technology. Dept. of Economics
The Physical Object
Pagination39, [7] p. :
Number of Pages39
ID Numbers
Open LibraryOL24639636M
OCLC/WorldCa51782406

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The 6D Bias and the Equity-Premium Puzzle 1. Introduction Consumption growth covaries only weakly with equity returns, which seems to imply that equities are not very risky. However, investors have historically received a very large premium for holding equities. For twenty years, economists have asked why an asset with little apparent. The 6D Bias and the Equity-Premium Puzzle 3. At reset date, consumption is c i w i, where is a function of the technology parameters, preference parameters, and D. 4. The equity share in the mutual fund is. (1) 2 Here c i represents consumption immediately after reset, and w i rep- resents wealth in the mutual fund immediately before reset. 1Introduction Consumptiongrowthcovariesonlyweaklywithequityreturns,whichimpliesthatequitiesarenot r. The 6D bias and the equity premium puzzle Xavier Gabaix MIT David Laibson Harvard University and NBER ∗ Current Draft: J First Draft: Aug Abstract If decision costs lead agents to update consumption every D periods, then econometricians will find an anomalously low correlation between equity returns and consumption.

If decision costs lead agents to update consumption every D periods, then econometricians will find an anomalously low correlation between equity returns and consumption growth (Lynch, ). We analytically characterize the dynamic properties of an economy composed of consumers who have such delayed updating. In our setting, an econometrician using an Euler equation procedure would infer a Cited by: The 6D bias and the equity premium puzzle Xavier Gabaix MIT David Laibson Harvard University and NBER∗ Current Draft: J First Draft: Aug   The 6d Bias and the Equity Premium Puzzle Harvard Institute of Economic Research Paper No. ; MIT Department of Economics Working Paper No. 47 Pages Posted: 17 Jan Cited by: “The 6D bias and the equity premium puzzle” is counterfactual, which is known as the ‘equity premium puzzle at long horizons’documentedbyCochraneandHansen(). There is a long list of variables that successfully predict stock returns in (iii). The list .

Downloadable! This paper argues that the high historical excess returns to equity are1 a result of a severe ex post bias over the period from to circa because inflation surprises during this period drove a wedge between ex ante and ex post returns to bonds. Furthermore, it is shown that ex ante and ex post returns to shares are identical in steady state. Elroy Dimson, Paul Marsh, Mike Staunton, The Worldwide Equity Premium: A Smaller Puzzle, Handbook of the Equity Risk Premium, /B, (), (). Crossref Pablo Fernandez, The Risk Premium in Books (in Spanish), SSRN Electronic Journal, /ssrn, (). June ; Current draft: J First draft: Aug Abstract. The 6D bias and the equity premium puzzle. By Xavier Gabaix and David LaibsonXavier Gabaix and David Laibson. Abstract. If decision costs lead agents to update consumption every D periods, then econometricians will find an anomalously low correlation between equity returns and consumption growth (Lynch ). We analytically characterize the.