The Relative Price Premium
95 Pages Posted: 3 Jan 2023 Last revised: 17 Jan 2025
Date Written: January 15, 2025
Abstract
This study shows that relative output price dispersion impacts risk premia. High price dispersion carries a negative price of risk, and firms associated with goods that have risen (fallen) in price compared to the PCE price index earn high (low) returns. We refer to this 0.35% per month return spread as the relative price premium. We rationalize these facts via a consumption-based model featuring imperfectly substitutable goods and an investor with preferences for the mix of goods consumed. Shocks to relative prices induce the investor to consume bundles that deviate from their desired mix, signaling bad times for the economy.
Keywords: Relative Prices, Asset Prices, Inflation, PCE, Dispersion
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