Using Asset Prices to Measure the Cost of Business Cycles

Posted: 2 Nov 2004

See all articles by Fernando Alvarez

Fernando Alvarez

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Urban J. Jermann

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

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Abstract

We measure the cost of consumption fluctuations using an approach that does not require the specification of preferences and instead uses asset prices. We measure the marginal cost of consumption fluctuations, the per unit benefit of a marginal reduction in consumption fluctuations expressed as a percentage of lifetime consumption. We find that the gains from eliminating all consumption uncertainty are very large. However, for consumption fluctuations corresponding to business cycle frequencies, we estimate the marginal cost to be between 0.08 percent and 0.49 percent of lifetime consumption.

Suggested Citation

Alvarez, Fernando and Jermann, Urban J., Using Asset Prices to Measure the Cost of Business Cycles. Available at SSRN: https://ssrn.com/abstract=612462

Fernando Alvarez (Contact Author)

University of Chicago - Department of Economics ( email )

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Urban J. Jermann

University of Pennsylvania - Finance Department ( email )

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