Asset pricing with utility from external anticipation

Vincenzo Merella

First

;Stephen E. Satchell

Second

2019-01-01

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Abstract

We show that augmenting household's preferences with utility from anticipation of external factors significantly improves the performance of the consumption-based asset pricing model. Specifically, our predictions match the realized returns on equity and on risk-free assets and helps in explaining the observed equity premium volatility. This is due to the novel forward-looking component of preferences exerting an effect on households' decision that countervails the standard market incentives to invest. Our findings stem from simulating the model with different data frequencies and confidence indicators as proxies for external anticipation. The model rationalizes the conventional wisdom that confidence makes households feel richer, hence willing to consume more. Our results also suggest that the observed predictive power of confidence on consumption growth might be justified by anticipatory utility.