Time-Varying State Variable Risk Premia in an ICAPM
46 Pages Posted: 17 Mar 2017 Last revised: 1 Feb 2020
Date Written: March 15, 2017
We find that the relation between state variables, such as the t-bill rate and term spread, and consumption growth is time-varying. In the cross-section of US stocks, risk premia for exposure to state variables vary over time accordingly. When a state variable predicts consumption strongly relative to its own history, its annualized risk premium increases by 6\% (0.4 in Sharpe ratio). This effect implies that risk premia can switch sign and is increasing in the conditional variance of the state variable. These common drivers of time-varying risk premia are consistent with the Intertemporal CAPM. Benchmark factors contain the same conditional expected return effects as state variable risk premia.
Keywords: Conditional Asset Pricing Models, State Variable Risk Premiums, Intertemporal CAPM, Time-Varying Consumption Predictability
JEL Classification: G12
Suggested Citation: Suggested Citation