Luxury Goods and the Equity Premium

This paper evaluates the equity premium using novel data on the consumption of luxury goods. Specifying household utility as a nonhomothetic function of the consumption of both a luxury good and a basic good, we derive pricing equations and evaluate the risk of holding equity. Household survey and national accounts consumption data overstate the risk aversion necessary to match the observed equity premium because they mostly reflect basic consumption. The risk aversion implied by equity returns and the consumption of luxury goods is more than an order of magnitude less than that implied by national accounts data. For the very rich, the equity premium is much less of a puzzle.