Consumption Volatility and the Cross-Section of Stock Returns
Review of Finance, Forthcoming
42 Pages Posted: 3 May 2007 Last revised: 11 Dec 2013
Date Written: November 2013
I derive and test multi-horizon implications of a consumption-based equilibrium model featuring ﬂuctuating expected growth and volatility. My setup allows consumption dynamics to be estimated jointly with covariance risk prices in a single-stage GMM, and then inferences from asset pricing tests reﬂect uncertainty coming from factor estimation. I show that changes in consumption volatility are the key driver for explaining major asset pricing anomalies across risk horizons, while other factors play no or a secondary role. Value stocks and past long-term losers pay higher average returns mainly because they covary more negatively with these changes than what other stocks do.
Keywords: Level Risk, Expected Growth Risk, Consumption Volatility Risk, GARCH, Kalman Filter
JEL Classification: G1, G12, G11, C1, C5
Suggested Citation: Suggested Citation