Frequency of Consumption Adjustment and the Equity Premium
30 Pages Posted: 9 Feb 2012 Last revised: 10 Oct 2012
Date Written: February 8, 2012
Abstract
We show that two types of consumption risk are priced in the equity premium: the risk of aggregate consumption growth and that of changing the composition of the consumption basket, when goods have heterogeneous costs of adjustment. We use the property that the frequency of consumption adjustment is inversely related to adjustment costs and split consumption into two components that proxy for consumption of low and high adjustment cost goods. We then estimate a version of the CCAPM with two components of consumption and show that our proposed split helps resolve the equity premium puzzle, while simultaneously generating sufficient volatility of marginal utility to satisfy volatility bounds at all frequencies.
Keywords: equity premium puzzle, CCAPM, consumption adjustment costs
JEL Classification: G12
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Consumption, Aggregate Wealth and Expected Stock Returns
By Martin Lettau and Sydney C. Ludvigson
-
Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles
By Ravi Bansal and Amir Yaron
-
Dividend Yields and Expected Stock Returns: Alternative Procedures for Interference and Measurement
-
Resurrecting the (C)Capm: A Cross-Sectional Test When Risk Premia are Time-Varying
By Martin Lettau and Sydney C. Ludvigson
-
Stock Return Predictability: Is it There?
By Geert Bekaert and Andrew Ang
-
Stock Return Predictability: Is it There?
By Geert Bekaert and Andrew Ang
-
Resurrecting the (C)Capm: A Cross-Sectional Test When Risk Premia Wre Time-Varying
By Martin Lettau and Sydney C. Ludvigson