Scale-Specific Risk in the Consumption CAPM
Federico M. Bandi
University of Chicago - Booth School of Business
London School of Economics & Political Science (LSE)
December 31, 2013
While contemporaneous consumption growth is known not to price the cross section of stock returns, we find that suitable sub-components (or details) of consumption growth with periodicities corresponding to the business cycle do. Specifically, we disaggregate consumption growth into details with different levels of persistence and show that those corresponding to business-cycle scales can explain 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 risk compensations in financial markets but also for capturing the joint 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 our proposed scale-based data generating process for consumption growth, we discuss implications for the cross-sectional pricing literature relying on aggregation.
Number of Pages in PDF File: 49
Keywords: C-CAPM, persistence heterogeneity in consumption, risk premia
JEL Classification: C22, C32, E32, E44, G12working papers series
Date posted: October 10, 2013 ; Last revised: January 30, 2014
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