Anticipatory Utility and Asset Pricing

Abstract

This paper formalizes the idea that individuals derive pleasure not only from current consumption, but also from the anticipation of future consumption. The model assumes that a single variable, namely, the stock of future consumption, captures all effects of future consumption on current well being. Consequently, consumers are dynamically consistent. The main implications of the model concern an additional incentive for savings, and an additional fundamental source of risk in financial markets. The model provides theoretical justification for using the consumption-wealth ratio to forecast asset returns. The model is calibrated and its restrictions on the joint behavior of aggregate consumption and asset returns are tested. The model justifies the equity premium, the risk-free rate, the volatility of the market returns, and the volatility of the risk-free rate. Importantly, the required levels of risk aversion and elasticity of intertemporal substitution are low. The estimation results show that the model is not rejected, and that the parameter estimates are economically plausible.