Consumption Disconnect Redux

Fisher College of Business Working Paper No. 2023-03-018

Charles A. Dice Working Paper No. 2023-18

79 Pages Posted: 23 Jun 2023 Last revised: 3 Jul 2023

See all articles by Alessandro Melone

Alessandro Melone

Ohio State University (OSU) - Fisher College of Business

Date Written: June 29, 2023


Several papers show that the apparent disconnect between stock returns and consumption growth is due to mismeasurement in standard consumption data, and propose to use new consumption measures instead. This paper finds that standard consumption is valuable for asset pricing if one focuses on consumption levels rather than growth. I analytically show that, when consumption levels contain a permanent and a transitory component, the latter—dubbed the consumption gap— should predict returns if the time series consumption-based model is valid. A simulated economy demonstrates that the relationship between expected returns and the consumption gap is robust to mismeasurement of consumption. Empirically, the consumption gap forecasts stock returns in-and out-of-sample at horizons from one quarter to five years, even after controlling for alternative popular predictors. This predictability generates significant economic value from the perspective of a mean variance investor. Finally, I use the cross-section of stocks to construct a heuristic stochastic discount factor that displays properties consistent with benchmark macro-finance models.

Keywords: Consumption Levels, Consumption-Based Asset Pricing, Return Predictability, Time- Varying Market Price of Risk, SDF

JEL Classification: C22, E32, E44, G12

Suggested Citation

Melone, Alessandro, Consumption Disconnect Redux (June 29, 2023). Fisher College of Business Working Paper No. 2023-03-018, Charles A. Dice Working Paper No. 2023-18, Available at SSRN: or

Alessandro Melone (Contact Author)

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

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