Asset Pricing with Countercyclical Household Consumption Risk

61 Pages Posted: 15 Feb 2014 Last revised: 11 Aug 2015

See all articles by George M. Constantinides

George M. Constantinides

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Anisha Ghosh

Carnegie Mellon University

Multiple version iconThere are 2 versions of this paper

Date Written: April 20, 2015

Abstract

We present evidence that shocks to household consumption growth are negatively skewed, persistent, countercyclical, and drive asset prices. We construct a parsimonious model where heterogeneous households have recursive preferences. A single state variable drives the conditional cross-sectional moments of household consumption growth. The estimated model fits well the unconditional cross-sectional moments of household consumption growth and the moments of the risk free rate, equity premium, price-dividend ratio, and aggregate dividend and consumption growth. The model-implied risk free rate and price-dividend ratio are pro-cyclical while the market return has countercyclical mean and variance. Finally, household consumption risk explains the cross-section of excess returns.

Keywords: household consumption risk, incomplete consumption insurance, idiosyncratic income shocks, asset pricing, equity premium puzzle, risk free rate puzzle, excess volatility puzzle

JEL Classification: D31, D52, E32, E44, G01, G12, J6

Suggested Citation

Constantinides, George M. and Ghosh, Anisha, Asset Pricing with Countercyclical Household Consumption Risk (April 20, 2015). Fama-Miller Working Paper, Available at SSRN: https://ssrn.com/abstract=2395522 or http://dx.doi.org/10.2139/ssrn.2395522

George M. Constantinides (Contact Author)

University of Chicago - Booth School of Business ( email )

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National Bureau of Economic Research (NBER)

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Anisha Ghosh

Carnegie Mellon University ( email )

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Pittsburgh, PA 15213-3890
United States

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