Long Run Risks and Equity Returns

53 Pages Posted: 22 Mar 2006  

Ravi Bansal

Duke University and NBER

Robert F. Dittmar

University of Michigan, Stephen M. Ross School of Business

Dana Kiku

University of Illinois at Urbana-Champaign

Date Written: March 2006

Abstract

We argue that investor concerns about the exposure of asset returns to permanent movements in consumption levels are a key determinant of the risk and return relation in asset markets. We show that as the investment horizon increases, (i) the return's systematic risk exposure (consumption beta) almost converges to the long-run relation between dividends and consumption, (ii) return volatility is increasingly dominated by dividend shocks. We find that most of the differences in risk premia, at short and long horizons, is due to the heterogeneity in the exposure to permanent risks in consumption. The long-run cross-sectional relation between risk and return provides a measure of the compensation for permanent risks in consumption. We find that the market compensation for these risks is large relative to that for transitory movements in consumption.

JEL Classification: G12,E32

Suggested Citation

Bansal, Ravi and Dittmar, Robert F. and Kiku, Dana, Long Run Risks and Equity Returns (March 2006). AFA 2007 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=891477 or http://dx.doi.org/10.2139/ssrn.891477

Ravi Bansal (Contact Author)

Duke University and NBER ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7758 (Phone)
919-660-8038 (Fax)

Robert F. Dittmar

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Dana Kiku

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

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