What Level of Fixed Costs Can Reconcile Asset Returns and Consumption Choices?

This paper defines a lower bound on the fixed cost that is required for observations on consumption choices to be consistent with data on asset returns and a given set of preferences. The bound is related to necessary conditions for optimal consumption and portfolio choice in the presence of fixed costs that reduce to standard Euler equations when actual fixed costs are zero. Conservative point estimates suggest that a consumer with log utility who consumes US per capita consumption must face a fixed cost of at least 3% of monthly per capita consumption. The fixed cost bound declines rapidly with increases in risk-aversion or when certain restrictions on short selling are included. Virtually the same fixed cost bounds are obtained when consumption growth is taken to be riskless.