Asset Pricing with Consumption Frictions

We study asset pricing with consumption frictions. Frictions in consumption include adjustment costs which prevent a consumer from adjusting consumption freely, due to transaction costs, commitments, search and learning costs, and psychological costs. The stochastic discount factor is determined by a marginal investor's marginal utility of adjustable consumption, and has the same form as that of the external habit model, similarly to the models with stock market non-participation. We next identify a potentially important source of risk for asset pricing: simultaneous adjustments of frictional consumption by a large number of population in the economy, which can have a large impact on interest rates. This risk is present neither in the habit model nor in other models, and provides another reason why governments and central banks are much concerned about households' consumption. However, the risk does not affect the market price of risk. We investigate the long-term behavior of asset prices, and show that equity strips have no excess volatility over zero-coupon bonds in the long run, if the stochastic discount factor admits the Hansen-Scheinkman decomposition with appropriate conditions