Using Asset Prices to Measure the Cost of Business Cycles

Abstract

We measure the cost of consumption fluctuations using an approach that does not require the specification of preferences and instead uses asset prices. We measure the marginal cost of consumption fluctuations , the per unit benefit of a marginal reduction in consumption fluctuations expressed as a percentage of lifetime consumption. We find that the gains from eliminating all consumption uncertainty are very large. However, for consumption fluctuations corresponding to business cycle frequencies, we estimate the marginal cost to be between 0.08 percent and 0.49 percent of lifetime consumption.