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Open Access Publications from the University of California

The double power law in consumption and implications for testing Euler equations

  • Author(s): Toda, AA
  • Walsh, K
  • et al.

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© 2015 by The University of Chicago. All rights reserved. We provide evidence suggesting that the cross-sectional distributions of US consumption and its growth rate obey the power law in both the upper and lower tails, with exponents approximately equal to four. Consequently, high-order moments are unlikely to exist, and the generalized method of moments estimation of Euler equations that employs cross-sectional moments may be inconsistent. Through bootstrap studies, we find that the power law appears to generate spurious nonrejection of heterogeneous-agent asset pricing models in explaining the equity premium. Dividing households into age groups, we propose an estimation approach that appears less susceptible to fat tail issues.

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