Optimizing Consumer and Excess Sensitivity

Abstract

We show that with the non-expected utility model of Epstein and Zin(1989, 1991) the excess sensitivity of consumption can be explained theoretically from the optimizing behavior through the market portfolio which includes the return on human capital. Also, using Farmer's (1990) model where stochastic income is explicitly included and risk is neutral, we show that the excess sensitivity of consumption to income is the prediction of the model through nonzero terms of human and nonhuman wealth in the stochastic process of consumption.