Approximate equilibrium asset prices

Abstract

Arguing that total consumer wealth is unobservable, we invert the (approximate) consumption function to reconstruct, in a world with Kreps-Porteus generalized isoelastic preferences, (i) the wealth that supports the agents' observed consumption as an optimal outcome and (ii) the rate of return on the consumers' wealth portfolio. This allows us to (approximately) price assets solely as a function of their payoffs and of consumption - in both homoskedastic or heteroskedastic environments. We compare implied equilibrium returns on the wealth portfolio to observed stock market returns and gauge whether the stock market is a good proxy for unobserved aggregate wealth. © The Authors 2009.