Equity Premia and State-Dependent Risks
CIRPEE Working Paper 10-19
43 Pages Posted: 21 May 2010
Date Written: May 20, 2010
This paper analyzes the empirical relations between equity premia and state-dependent consumption and market risks. These relations are derived from a flexible specification of the CCAPM with mixture distribution, which admits the existence of two regimes. Focusing on the market return, we find that the consumption and market risks are priced in each state, and the responses of expected equity premia to these risks are state dependent. Extending to various portfolio returns, we show that the responses to downside consumption risks are the most important, they are almost always statistically larger than the responses to upside consumption risks, and they are much larger for firms having smaller sizes and facing more financial distresses.
Keywords: Mixture of truncated normals, downside and upside consumption and market risks
JEL Classification: C16, G12
Suggested Citation: Suggested Citation