Consumption-Based Asset Pricing: Durable Goods, Adjustment Costs, and Aggregation

In this paper, we investigate the implications of non-separable preferences over durable and nondurable consumption for asset pricing tests when adjusting durable consumption is costly. In an economy without adjustment costs, in which a frictionless rental market exists for the durable good, the standard Euler equation with respect to nondurable consumption will hold for each individual agent as well as for aggregate data. If the adjustment of the durable good is costly, however, aggregation generally fails. We use aggregate data to find substantial deviations from the frictionless model, consistent with the presence of non-convex adjustment costs for the durable good. We also show how empirical asset pricing tests that use aggregate data can be affected by these deviations. We then propose and implement asset pricing tests that are robust to the presence of adjustment costs by relying on microeconomic data. Using household-level observations of nondurable food and durable housing consumption, our estimation results suggest that preferences are indeed non-separable in the two consumption goods and that reasonable structural parameters characterize agents' intertemporal utility optimizations.