Identifying Preferences when Households are Financially Constrained

TL;DR

This paper demonstrates that considering the extensive margin of financially constrained households refines preference estimates in macroeconomic models, aligning them more closely with microeconomic data and improving asset pricing accuracy.

Contribution

It introduces a method to incorporate the extensive margin of constrained households into macro models, enhancing the estimation of preferences and market distortions.

Findings

Using Spanish data supports the importance of the extensive margin.

Accounting for constraints improves asset pricing models.

Inclusion of the extensive margin aligns macro estimates with micro evidence.

Abstract

This paper shows that utilizing information on the extensive margin of financially constrained households can narrow down the set of admissible preferences in a large class of macroeconomic models. Estimates based on Spanish aggregate data provide further empirical support for this result and suggest that accounting for this margin can bring estimates closer to microeconometric evidence. Accounting for financial constraints and the extensive margin is shown to matter for empirical asset pricing and quantifying distortions in financial markets.