Government Spending Shocks, Consumption Dynamics, and Asset Prices

45 Pages Posted: 25 Jun 2016 Last revised: 2 Jun 2023

See all articles by Ruchith Dissanayake

Ruchith Dissanayake

Queensland University of Technology - School of Economics and Finance

Date Written: June 1, 2023

Abstract

Using an improved stock return-based measure that is uncorrelated with business cycle conditions, I examine the implications of government spending shocks on consumption dynamics and asset pricing. Estimates from vector autoregressions and local projections using monthly data show that government spending causes a short-term increase and a subsequent decrease in consumption. Non-linear models show that short-term increases in consumption occur only during recessions. In contrast, government spending causes substantial reductions in consumption during growth periods. Government spending shocks are associated with a risk premium in the time-series and cross-section of returns. Commonly used factor models fail to capture this premium.

Keywords: government spending shock, DMP returns, consumption growth, two-state model, factor model

JEL Classification: G12, E62, N42

Suggested Citation

Dissanayake, Ruchith, Government Spending Shocks, Consumption Dynamics, and Asset Prices (June 1, 2023). 29th Australasian Finance and Banking Conference 2016, Available at SSRN: https://ssrn.com/abstract=2799778 or http://dx.doi.org/10.2139/ssrn.2799778

Ruchith Dissanayake (Contact Author)

Queensland University of Technology - School of Economics and Finance ( email )

GPO Box 2434
2 George Street
Brisbane, Queensland 4001
Australia

HOME PAGE: http://www.rdissanayake.com

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