Asset Pricing With and Without Garbage: Testability of Consumption-based Models

This paper challenges the view that alternative consumption measures (e.g., garbage, fourth quarter, unfiltered consumption) can address the empirical shortcomings of consumption-based asset pricing. Instead, we show that testing alternative consumption processes is a triple hypothesis problem, which, in addition to finding the most accurate consumption measure, requires specifying and estimating the dynamics of consumption growth and testing the functional form of investor preferences. The existing literature tends to make strong assumptions on consumption dynamics (i.i.d.) and investor preferences (CRRA). We show that relaxing these assumptions leads to different results regarding the fit and preference parameters of the various consumption measures.