Composition of Wealth, Conditioning Information, and the Cross-Section of Stock Returns

Abstract:     
Value stocks covary with aggregate consumption more than growth stocks during periods when financial wealth is low relative to consumption. However, the conditional value premium does not exhibit such countercyclical behavior. Consequently, a one-factor conditional consumption-based asset pricing model can be rejected without making any arbitrary assumptions on the dynamics of the price of risk or the conditional moments. Empirical evidence is somewhat more consistent with a consumption-based model augmented with an aggregate wealth growth factor, which can be motivated by recursive preferences or relative wealth concerns.

Number of Pages in PDF File: 93

Keywords: consumption-based asset pricing, conditioning information, human capital, stock return predictability, nonparametric regression, value premium, linear factor models, relative wealth concerns.

JEL Classification: G120, G100, C140

Accepted Paper Series