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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page A Note on the Cointegration of Consumption, Income, and Wealth
Jeremy Rudd and Karl Whelan

Abstract: Lettau and Ludvigson (2001) argue that a log-linearized approximation to an aggregate budget constraint predicts that log consumption, assets, and labor income will be cointegrated. They conclude that this cointegrating relationship is present in U.S. data, and that the estimated cointegrating residual forecasts future asset growth. This note examines whether the cointegrating relationship suggested by Lettau and Ludvigson's theoretical framework actually exists. We demonstrate that we cannot reject the hypothesis that cointegration is absent from the data once we employ measures of consumption, assets, and labor income that are jointly consistent with an underlying budget constraint. By contrast, Lettau and Ludvigson use a set of variables that do not belong together in an aggregate budget constraint, thereby testing a cointegrating relationship that is not implied by their theory.

Keywords: Consumption, asset returns, cointegration, budget constraints

Full paper (205 KB PDF)

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Last update: November 18, 2002