S-Shaped Consumption Utility: Empirical Evidence and Implications

Abstract

Using a macro quantile factor model, we examine cross-state (i.e., cross-quantile) heterogeneity in consumption behaviors. We find that common macro factors generate a “big bang/crunch” effect on micro consumption. Generally speaking, when the aggregate effect of the common factors on the consumption in low consumption-growth states is negative (resp. positive), this effect in high consumption-growth states is positive (resp. negative). The big bang/crunch suggests that consumption utility functions are not concave-shaped but S-shaped. We justify the S shape using consumption-based asset pricing. We show that various consumption-based asset pricing puzzles arise from the global concavity of the utility functions, and the S-shaped consumption utility offers a solution. Also, the S-shaped utility helps explain the low elasticity of intertemporal substitution reported in the literature. In addition, we propose a simple estimation method that allows one to estimate the macro quantile factor model with big data.