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Long Run Risk and the Persistence of Consumption Shocks

62 Pages Posted: 22 Nov 2010 Last revised: 1 Jun 2013

Fulvio Ortu

Bocconi University - Department of Finance

Andrea Tamoni

London School of Economics & Political Science (LSE)

Claudio Tebaldi

Bocconi University, IGIER and CAREFIN

Date Written: May 26, 2013

Abstract

We propose a methodology based on multiresolution analysis to decompose a time series in components classifi ed by their level of persistence. Using this decomposition to detect the layers with diff erent degrees of persistence in consumption growth, we provide empirical evidence that some of the consumption components are predictable and highly correlated with well known economic proxies of consumption variability. These predictable components generate a term-structure of sizable risk premia in a long-run risk model properly modifi ed to account for the diff erent layers of persistence. A low frequency component correlated with long-run productivity growth commands a premium of up to 2% per year when the risk aversion takes the reasonable value of 7.5 and the IES is 2.5. On the high-frequency side, a component with yearly half-life contributes to another sizable 2%. By accounting for persistence heterogeneity in consumption we obtain, moreover, an estimate of the IES strictly greater than one and robust across subsamples.

Keywords: Long-run risk, Persistence heterogeneity, Temporal aggregation, Consumption predictability

JEL Classification: G12, E21, E32, E44

Suggested Citation

Ortu, Fulvio and Tamoni, Andrea and Tebaldi, Claudio, Long Run Risk and the Persistence of Consumption Shocks (May 26, 2013). Available at SSRN: https://ssrn.com/abstract=1713295 or http://dx.doi.org/10.2139/ssrn.1713295

Fulvio Ortu

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Andrea Tamoni (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
02079557303 (Phone)

Claudio Tebaldi

Bocconi University, IGIER and CAREFIN ( email )

Via Roentgen 1
Milan, 20136
Italy

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