Time-Varying State Variable Risk Premia in an ICAPM

46 Pages Posted: 17 Mar 2017 Last revised: 1 Feb 2020

See all articles by Pedro Barroso

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics

Martijn Boons

Tilburg University

Paul Karehnke

ESCP Business School

Date Written: March 15, 2017

Abstract

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

Barroso, Pedro and Boons, Martijn and Karehnke, Paul, Time-Varying State Variable Risk Premia in an ICAPM (March 15, 2017). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=2933449 or http://dx.doi.org/10.2139/ssrn.2933449

Pedro Barroso

CATÓLICA-LISBON School of Business & Economics ( email )

Palma de Cima
Lisbon, Lisboa 1649-023
Portugal

HOME PAGE: http://https://clsbe.lisboa.ucp.pt/person/pedro-monteiro-e-silva-barroso

Martijn Boons (Contact Author)

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

Paul Karehnke

ESCP Business School ( email )

79 avenue de la République
75011
France

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