Business-Cycle Consumption Risk and Asset Prices
Federico M. Bandi
University of Chicago - Booth School of Business
London School of Economics & Political Science (LSE)
May 9, 2015
We show that a business-cycle consumption factor can explain satisfactorily the differences in risk premia across book-to-market and size-sorted portfolios. We argue that explicit allowance for consumption fluctuations with heterogeneous durations is important for interpreting cross-sectional pricing as well as the time-series dynamics of consumption and returns across horizons (i.e., the hump-shaped pricing ability of the covariance between "ultimate consumption" and returns, the hump-shaped structure of long-run risk premia, the decaying pattern in consumption growth predictability). Using a novel modeling approach, we justify results on aggregation in the asset pricing literature.
Number of Pages in PDF File: 57
Keywords: C-CAPM, persistence heterogeneity in consumption, risk premia
JEL Classification: C22, C32, E32, E44, G12
Date posted: October 10, 2013 ; Last revised: May 9, 2015
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