Mean Reversion and Consumption Smoothing

16 Pages Posted: 16 Jun 2004 Last revised: 22 Jul 2022

See all articles by Fischer Black

Fischer Black

Sloan School of Management, MIT (Deceased)

Date Written: April 1989

Abstract

Using a simple conventional model with additive separable utility and constant elasticity, we can explain mean reversion and consumption smoothing. The model uses the price of risk and wealth as state variables, but has only one stochastic variable. The price of risk rises temporarily as wealth falls. We also distinguish between risk aversion and the consumption elasticity of marginal utility. We can use the model to match estimates of the average values of consumption volatility, wealth volatility, mean reversion, the growth rate of consumption, the real interest rate, and the market risk premium.

Suggested Citation

Black, Fischer, Mean Reversion and Consumption Smoothing (April 1989). NBER Working Paper No. w2946, Available at SSRN: https://ssrn.com/abstract=227220

Fischer Black (Contact Author)

Sloan School of Management, MIT (Deceased)

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