Consumption Risk and Cross-Sectional Returns

46 Pages Posted: 13 Mar 2003 Last revised: 31 Oct 2010

See all articles by Christian Julliard

Christian Julliard

London School of Economics & Political Science (LSE) - Department of Finance; Centre for Economic Policy Research (CEPR)

Jonathan A. Parker

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: March 2003

Abstract

This paper evaluates the central insight of the Consumption Capital Asset Pricing Model (C-CAPM) that an asset's expected return is determined by its equilibrium risk to consumption. Rather that measure the risk of a portfolio by the contemporaneous covariance of its return and consumption growth -- as done in the previous literature on the C-CAPM and the pattern of cross-sectional returns -- we measure the risk of a portfolio by its ultimate consumption risk defined as the covariance of its return and consumption growth over the quarter of the return and many following quarters. While contemporaneous consumption risk has little predictive power for explaining the pattern of average returns across the Fama and French (25) portfolios, ultimate consumption risk is highly statistically significant in explaining average returns and explains a large fraction of the variation in average returns. Aditionally, estimates of the average risk-free real rate of interest and the coefficient of relative risk aversion of the representative household based on ultimate consumption risk are more reasonable than those obtained using contemporaneous consumption risk.

Suggested Citation

Julliard, Christian and Parker, Jonathan A., Consumption Risk and Cross-Sectional Returns (March 2003). NBER Working Paper No. w9538, Available at SSRN: https://ssrn.com/abstract=386167

Christian Julliard

London School of Economics & Political Science (LSE) - Department of Finance ( email )

United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Jonathan A. Parker (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Cambridge, MA
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National Bureau of Economic Research (NBER)

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