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
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