As emphasized by Giovannini and Labadie (1991), empirical regularities involving nominal interest rates, asset prices, and inflation should be ultimately determined by money. The role of money, however, is almost neglected, particularly in terms of asset-pricing literature. This paper attempts to investigate the role of money in asset pricing in Japan. Specifically, it compares the empirical performance of stochastic discount factors derived from (i) the standard C-CAPM, (ii) the habit formation model, (iii) the money-in-the-utility model, and (iv) the cash-in-advance model. Empirical results show that in terms of the underlying parameters estimated by Hansen's (1982) Generalized Method of Moments (GMM), the habit formation and the cash-in-advance models are almost always rejected, although no significant difference is found in terms of the volatility bound test among models. The specification test between the standard C-CAPM and the money-in-the-utility model generally favors the latter, implying that there is a positive role of money in specifying the stochastic discount factor.
Keywords: Asset pricing; CAPM; Money-in-the-utility; Cash-in-advance; Habit formation; Volatility bound; Market frictions
Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.