Asset pricing in economies with frictions

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This paper examines how proportional transaction costs, short-sale constraints, and margin requirements affect inferences based on asset return data about intertemporal marginal rates of substitution (IMRSs). It is shown that small transaction costs can greatly reduce the required variability of IMRSs. This suggests that the low variability of many parametric, aggregate consumption based IMRSs need not be inconsistent with asset return data. Euler inequalities for a transaction cost economy with power utility are tested using aggregate consumption data and returns on stocks and short maturity U.S. Treasury bills. In the majority of cases there is little evidence against power utility specifications with low risk-aversion parameters. The results are obtained with transaction costs on stocks as small as .5% of price, and are in sharp contrast to the strong rejection of the analogous Euler equalities for a frictionless economy.

Original languageEnglish (US)
Pages (from-to)1439-1467
Number of pages29
Issue number6
StatePublished - Nov 1996


  • Aggregate consumption
  • Asset pricing
  • Borrowing constraints
  • Transaction costs
  • Variability of IMRSs


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