A FINANCE APPROACH TO ESTIMATING CONSUMPTION PARAMETERS

This paper relates consumption economics more closely to an aggregate financial variable than in any previous research. We compile the net real rate of return on a synthetic mutual fund (SMF) encompassing all major classes of financial assets and residential real estate. Return on the SMF better represents the market return of financial portfolio theory than any measure in use today and we demonstrate its merit in an expected utility model to estimate consumption parameters, the coefficient of relative risk aversion (CRRA), and intertemporal elasticity of substitution (IES). The estimates are stable across varying time periods and alternative measures of consumption. (JEL E21, D91, G11, C13)