Consumption Heterogeneity and Long Run Risk
25 Pages Posted: 15 Feb 2008
Date Written: February 10, 2008
This paper establishes a surprising and robust empirical similarity between short-run heterogeneous consumption and long-term consumption growth risk models. The models not only deliver a similar fit on a given set of portfolios, their actual pricing errors are also highly correlated. In addition, we find that consumption dispersion is a robust predictor of the transitory component in aggregate consumption growth. To interpret these findings, we propose a model in which aggregate uncertainty is a function of idiosyncratic uncertainty and only long-term consumption growth risk is priced. An implication of this being that consumption dispersion is priced empirically not because markets are necessarily incomplete but because investors disagree in the short-run about their common long-term consumption prospects.
Keywords: consumption CAPM, idiosyncratic risk, consumption dispersion
JEL Classification: E21, F30, G15
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