Business-Cycle Consumption Risk and Asset Prices

Abstract:     

We show that a business-cycle consumption factor can explain the differences in risk premia across alternative portfolios, including recently-proposed anomalies portfolios. We argue that explicit allowance for a separation between consumption fluctuations with heterogeneous durations is important for interpreting cross-sectional pricing as well as the time-series dynamics of consumption and returns across horizons (i.e., the hump-shaped pricing ability of the covariance between ultimate consumption and returns, the hump-shaped structure of long-run risk premia, the decaying pattern in consumption growth predictability). Using a novel modeling approach relying on a frequency-based decomposition, we formalize the important role that aggregation can play in asset pricing.

Number of Pages in PDF File: 64

Keywords: C-CAPM, persistence heterogeneity in consumption, risk premia

JEL Classification: C22, C32, E32, E44, G12