Abstract
This paper shows that consumption-based asset pricing puzzles arise from using globally concave-shaped consumption utility. We empirically find that asset returns correlate negatively with many individuals’ low-quantile consumption growth. This finding challenges most mainstream models and supports an asset pricing model based on S-shaped consumption utility. This new model explains both the low covariance between consumption growth and stock returns and a high equity premium. Moreover, this model shows that applying globally concave-shaped consumption utility mistakenly leads to a positive correlation between risky returns and stochastic discount factors of many individuals, a root for many pricing anomalies.
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