The Wealth-Consumption Ratio: A Litmus Test for Consumption-based Asset Pricing Models

Abstract

We propose a new method to measure the wealth-consumption ratio, the price-dividend ratio of a claim to aggregate consumption. It combines no-arbitrage restrictions with data on bond yields and stock returns. The estimated wealth-consumption ratio is much higher on average than the price-dividend ratio on stocks and has lower volatility. This implies that the consumption risk premium is substantially below the equity risk premium, or that total wealth is less risky than stock market wealth. Measuring the wealth-consumption ratio is important because changes in the wealth-consumption ratio enter as a second asset pricing factor besides consumption growth in the two leading representative-agent asset pricing models, the external habit model and the long-run risk model. The benchmark calibrations of these two asset pricing models have dramatically different implications for the wealth-consumption ratio, motivating our measurement exercise.