Educator; Entrepreneur; Alpha Architect CEO/CIO

If you are into consumption-based asset pricing theory and the associated empirical attempts to reconcile the theory with the data from the realized equity premium, garbage is a fascinating subject.

So let’s talk about asset pricing both with–and without–garbage.

First the original paper on asset pricing with garbage.

The original paper by an old friend and former PhD buddy, Alexi Savov.

Asset Pricing with Garbage

A new measure of consumption, garbage, is more volatile and more correlated with stocks than the canonical measure, National Income and Product Accounts (NIPA) consumption expenditure. A garbage-based consumption capital asset pricing model matches the U.S. equity premium with relative risk aversion of 17 versus 81 and evades the joint equity premium-risk-free rate puzzle. These results carry through to European data. In a cross-section of size, value, and industry portfolios, garbage growth is priced and drives out NIPA expenditure growth.

and now a new paper…

Asset Pricing without Garbage

This paper provides an explanation for why garbage implies a much lower relative risk aversion in the consumption-based asset pricing model than National Income and Product Accounts (NIPA) consumption expenditure: unlike garbage, NIPA consumption is filtered to mitigate measurement error. I apply a simple model of the filtering process that allows one to undo the filtering inherent in NIPA consumption. “Unfiltered NIPA consumption” well explains the equity premium and is priced in the cross-section of stock returns. I discuss the likely properties of true consumption (i.e., without measurement error and filtering) and quantify implications for habit and long-run risk models.

If you aren’t into really geeking out then consider this post a “garbage in, garbage out” situation. har har…

PS. How about those Olympians last night? Incredible performances in the pool and the gym!!!

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