Consumption Risk and Expected Stock Returns

18 Pages Posted: 8 Mar 2003 Last revised: 1 Nov 2010

See all articles by Jonathan A. Parker

Jonathan A. Parker

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

Date Written: March 2003

Abstract

Following the textbook C-CAPM, the consumption risk of an asset is typically measured as the contemporaneous covariance of the marginal utility of consumption and the return on that asset. When measured this way, consumption risk is too small to explain the observed equity premium, is negatively related to expected excess returns over time, and fails to explain the cross-sectional differences in average returns of the Fama and French (25) portfolios. This paper evaluates the central insight of the C-CAPM - that consumption risk determines returns - but take the model less literally by allowing the possibility that households do not instantaneously and completely adjust consumption to the news revealed about wealth in a period. The long-term consumption risk of the aggregate market is signficantly larger than the contemporaneous risk and is positively related to expected excess returns over time. The long-term consumption risk of different portfolios largely explains the observed differences in average returns.

Suggested Citation

Parker, Jonathan A., Consumption Risk and Expected Stock Returns (March 2003). NBER Working Paper No. w9548, Available at SSRN: https://ssrn.com/abstract=386177

Jonathan A. Parker (Contact Author)

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