Business-Cycle Consumption Risk and Asset Prices
Federico M. Bandi
University of Chicago - Booth School of Business
London School of Economics & Political Science (LSE)
September 30, 2014
We disaggregate consumption growth into components with different levels of persistence and show that a single business-cycle consumption factor can explain satisfactorily the differences in risk premia across book-to-market and size-sorted portfolios. We argue that accounting for persistence heterogeneity in consumption is important for interpreting cross-sectional risk compensations in financial markets but also for capturing the joint time-series dynamics of consumption and returns across horizons (for instance, the hump-shaped pricing ability of the covariance between "ultimate consumption" and returns, the hump-shaped structure of long-run risk premia as well as the decaying pattern in consumption growth predictability). Using a novel time/frequency-based data generating process for consumption growth and asset returns, we discuss implications for the asset pricing literature relying on aggregation.
Number of Pages in PDF File: 50
Keywords: C-CAPM, persistence heterogeneity in consumption, risk premia
JEL Classification: C22, C32, E32, E44, G12
Date posted: October 10, 2013 ; Last revised: October 3, 2014
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