Consumption Volatility Risk

Abstract

We show that time-variation in macroeconomic uncertainty affects asset prices. Consumption volatility is a negatively priced source of risk for a wide variety of test assets. At the firm level, exposure to consumption volatility risk predicts future returns, generating a spread across quintile portfolios in excess of 7% annually. This premium is explained by cross-sectional differences in the sensitivity of dividend volatility to consumption volatility. Stocks with volatile cash flows in uncertain aggregate times require higher expected returns.

Keywords: Asset pricing, consumption volatility, cross section of returns, cash flow risk, recursive preferences.

JEL Classification: G12, G17, E44.