Durable Matters? An Alternative Measure of Consumption Risk

55 Pages Posted: 21 Aug 2012  

Rui Cui

University of Chicago - Finance

Date Written: August 20, 2012

Abstract

Empirical proxies for permanent shocks to durables consumption growth are shown to generate strong pricing implications for both one-period and long-run risk return tradeoff in a cross-section of test assets. This factor is identified as an additional source of consumption risk in a structural model where investors are endowed with recursive preferences over consumption of both durable and nondurable goods whose growth rates are predictable. In the data, small stocks, value stocks and treasury bonds with longer maturities covary more strongly with this factor than big stocks, growth stocks and treasury bonds with shorter maturities, thus generating higher expected return. My estimation implies reasonable magnitude of risk aversion. Next, I apply dynamic value decomposition method in conjunction with my economic model to analyze cash flows from value and growth portfolios. Incorporating durable consumption identifies significant heterogeneity in the stationary component of these cash flows, but only negligible difference in their martingale component. This suggests higher risk premium associated with holding the near end, rather than far end, of cash flow components from value portfolio could be an important contributor to the well known value premium.

Keywords: durable goods, value premium, dynamic value decomposition

JEL Classification: G12, C51

Suggested Citation

Cui, Rui, Durable Matters? An Alternative Measure of Consumption Risk (August 20, 2012). 25th Australasian Finance and Banking Conference 2012. Available at SSRN: https://ssrn.com/abstract=2133038 or http://dx.doi.org/10.2139/ssrn.2133038

Rui Cui (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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