Evidence that Risk Adjustment is Unnecessary in Estimates of the User Cost of Money

Main Article Content

Diego A. Restrepo-Tobón


Money, User cost, Habit formation, Asset pricing


Investors value the  special attributes of monetary assets (e.g.,  exchangeability, liquidity, and safety)  and pay a premium for holding them in the form of a lower return rate. The user cost of holding monetary assets can be measured approximately by the difference between the  returns on illiquid risky assets and  those of safer liquid assets. A more appropriate measure should adjust this difference by the  differential risk of the  assets in question. We investigate the  impact that time  non-separable preferences has on the  estimation of the  risk-adjusted user cost of money. Using U.K. data from 1965Q1 to 2011Q1, we estimate a habit-based asset pricing model  with money  in the utility function and  find that the  risk  adjustment for risky monetary assets is negligible. Thus, researchers can dispense with risk adjusting the  user cost of money  in constructing monetary aggregate indexes.


Download data is not yet available.
Abstract 877 | PDF Downloads 383 HTML Downloads 234


Abel, A. B., May 1990. Asset Pricing under Habit Formation and Catching Up with the Joneses. American Economic Review (Papers and Proceedings) 80 (2), 38–42.

Anderson, R., Buol, J., 2005. Revisions to user costs for the Federal Reserve Bank of St. Louis monetary services indices. Review Federal Reserve Bank of Saint Louis 87 (6), 735.

Anderson, R., Jones, B., 2011. A comprehensive revision of the US monetary services (Divisia) indexes. Federal Reserve Bank of St. Louis Review 93 (5), 235–59.

Andrews, D., 1991. Heteroskedasticity and autocorrelation consistent covariance matrix estimation. Econometrica: Journal of the Econometric Society, 817–858.

Antoine, B., Bonnal, H., Renault, E., 2007. On the efficient use of the informational content of estimating equations: Implied probabilities and Euclidean empirical likelihood. Journal of Econometrics 138 (2), 461 – 487.

Barnett, W., 1978. The user cost of money. Economics Letters 1 (2), 145–149.

Barnett, W., Offenbacher, E., Spindt, P., 1981. New Concepts of Aggregated Money. The Journal of Finance 36 (2), 497–505.

Barnett, W. A., Liu, Y., Jensen, M., June 1997. Capm Risk Adjustment For Exact Aggregation Over Financial Assets. Macroeconomic Dynamics 1 (02), 485–512.

Barnett, W. A., Wu, S., 2005. On user costs of risky monetary assets. Annals of Finance 1 (1), 35–50. Boldrin, M., Christiano, L. J., Fisher, J. D. M., 2001. Habit Persistence, Asset Returns, and the Business Cycle. The American Economic Review 91 (1), pp. 149–166.

Buraschi, A., Jiltsov, A., 2007. Habit Formation and Macroeconomic Models of the Term Structure of Interest Rates. Journal of Finance 62 (6), 3009 – 3063.

Campbell, J. Y., Cochrane, J. H., Apr. 1999. By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior. Journal of Political Economy 107 (2), 205–251.

Chen, X., Ludvigson, S. C., 2009. Land of addicts? an empirical investigation of habit-based asset pricing models. Journal of Applied Econometrics 24 (7), 1057–1093.

Constantinides, G. M., Jun. 1990. Habit Formation: A Resolution of the Equity Premium Puzzle. Journal of Political Economy 98 (3), 519–543.

Donald, S. G., Newey, W. K., 2000. A jackknife interpretation of the continuous updating estimator. Economics Letters 67 (3), 239 – 243.

Elger, T., Binner, J., 2004. The UK Household Sector Demand for Risky Money. The B.E. Journal of Macroeconomics 4 (1), 1–22.

Engle, R., 2002. Dynamic conditional correlation. Journal of Business & Economic Statistics 20 (3), 339–350.

Epstein, L. G., Zin, S. E., Apr. 1991. Substitution, Risk Aversion, and the Temporal Behavior of Consumption Growth and Asset Returns II: An Empirical Analysis. Journal of Political Economy 9 (2), 263–286.

Fuhrer, J., 2000. Habit formation in consumption and its implications for monetary-policy models. American Economic Review, 367–390.

Gregory, A., Tharyan, R., Huang, A., 2009. The Fama-French and momentum portfolios and factors in the UK. University of Exeter Business School, Xfi Centre for Finance and Investment Paper (09/05). Hancock, M., 2005a. A new measure of Divisia money. Bank of England Monetary & Financial Statistics, 13–14.

Hancock, M., 2005b. Divisia money. Bank of England Quarterly Bulletin, Spring.

Hansen, L. P., Heaton, J., Yaron, A., 1996. Finite-Sample Properties of Some Alternative GMM Estima- tors. Journal of Business & Economic Statistics 14 (3), pp. 262–280.

Hansen, L. P., Singleton, K. J., September 1982. Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models. Econometrica 50 (5), 1269–86.

Hyde, S., Sherif, M., 2005a. Consumption Asset Pricing Models: Evidence from the UK. The Manchester School 73 (3), 343–363.

Hyde, S., Sherif, M., 2005b. DonŠt break the habit: structural stability tests of consumption asset pricing models in the UK. Applied Economics Letters 12 (5), 289 – 296.

Jones, B. E., Stracca, L., 2008. Does money matter in the IS curve? The case of the U.K. The Manchester School 76, 58–84.

Krishnamurthy, A., Vissing-Jorgensen, A., 2012. The aggregate demand for treasury debt. Journal of Political Economy 120 (2), 233–267.

Lagos, R., 2010. Asset prices and liquidity in an exchange economy. Journal of Monetary Economics 57 (8), 913 – 930.

Lagos, R., 2011. Asset prices, liquidity, and monetary policy in an exchange economy. Journal of Money, Credit and Banking 43 (s2), 521–552.

Møller, S., 2009. Habit persistence: explaining cross-sectional variation in returns and time-varying expected returns. Journal of Empirical Finance 16 (4), 525–536.

Newey, W., West, K., 1987. A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica: Journal of the Econometric Society, 703–708.

Powell, M., 1994. A direct search optimization method that models the objective and constraint functions by linear interpolation. Advances in optimization and numerical analysis 7, 51–67.

Stock, J., Wright, J., Yogo, M., 2002. A survey of weak instruments and weak identification in generalized method of moments. Journal of Business & Economic Statistics 20 (4), 518–529.

Stock, J. H., Wright, J. H., 2000. GMM with Weak Identification. Econometrica 68 (5), 1055–1096. Tallarini, T. D., Zhang, H. H., 2005. External Habit and the Cyclicality of Expected Stock Returns. The Journal of Business 78 (3), pp.1023–1048.

Verdelhan, A., 2010. A Habit-Based Explanation of the Exchange Rate Risk Premium. The Journal of Finance 65 (1), 123–146.

Wachter, J. A., 2006. A consumption-based model of the term structure of interest rates. Journal of Financial Economics 79 (2), 365 – 399.

Yogo, M., 2006. A Consumption-Based Explanation of Expected Stock Returns. The Journal of Finance 61 (2), 539–580.