Leisure, Consumption and Long Run Risk: An Empirical Evaluation
Autonomous University of Barcelona
November 19, 2012
Paris December 2012 Finance Meeting EUROFIDAI-AFFI Paper
I study a long-run risk model with non-separable consumption and leisure in the Epstein-Zin preferences to price a cross-section of equity assets over 1948-2011 for the U.S. market. I show that equity returns are explained by news on consumption and leisure. Substituting from consumption, leisure acts as a `hedge' while waiting for future investment opportunities. Hence, rational long-term investors ask for relatively lower compensation for the predominant long-run leisure risk. Estimating long-run consumption and leisure factors using a VAR with state variables that predict consumption and leisure growth, I find that growth (big) stocks obtain higher long-run leisure betas but lower long-run consumption betas than value (small) stocks, and this can explain their lower average returns. My model does well, in terms of a variety of criteria, relative to competing models in explaining, for example, the size and value `anomalies' in stock returns.
Number of Pages in PDF File: 49
Keywords: Epstein-Zin Utility, Long Run Risk, Leisure, Value-Growth Portfolios, Vector Auto-regression
JEL Classification: G12, G17, N22working papers series
Date posted: June 11, 2012 ; Last revised: March 27, 2013
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