Consumption Growth Predictability and Asset Prices

66 Pages Posted: 2 Apr 2019

See all articles by Tai-Yong Roh

Tai-Yong Roh

Liaoning University

Changjun Lee

Hankuk University of Foreign Studies

Byoung-Kyu Min

Hanyang University

Date Written: February 27, 2013

Abstract

We derive and test a consumption-based intertemporal asset pricing model in which an asset earns a risk premium if it performs poorly when expected future consumption growth deteriorates. The predictability of consumption growth combined with the recursive preference delivers news about future consumption growth an additional risk factor, in addition to news about current consumption growth. We model the consumption growth dynamics using a vector autoregressive (VAR) structure with a set of instrumental variables commonly used for forecasting future economic growth. Our VAR estimation provides strong empirical support for future consumption growth predictability. The cross-sectional test shows that the model explains reasonably well the dispersion in average excess returns of 25 portfolios sorted on size and book-to-market, as well as 25 portfolios sorted on size and long-term return reversal. Growth stocks and long-term winners underperform value stocks and long-term losers, respectively, because growth stocks and long-term winners hedge adverse changes in the future consumption growth opportunities.

Keywords: Consumption-based asset pricing model, Consumption growth predictability, Recursive preference, Value premium, Long-term return reversal

JEL Classification: E21, E44, G12

Suggested Citation

Roh, Tai-Yong and Lee, Changjun and Min, Byoung-Kyu, Consumption Growth Predictability and Asset Prices (February 27, 2013). Journal of Empirical Finance, Vol. 51, 2019, Available at SSRN: https://ssrn.com/abstract=3349943

Tai-Yong Roh

Liaoning University ( email )

Shenyang, Liaoning
China

Changjun Lee

Hankuk University of Foreign Studies ( email )

270 Imun-dong Dongdaemun-gu
Seoul, 130-791
Korea, Republic of (South Korea)

Byoung-Kyu Min (Contact Author)

Hanyang University ( email )

Seoul
Korea, Republic of (South Korea)

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