Cointegration and Consumption Risks in Asset Returns

52 Pages Posted: 27 Jun 2007 Last revised: 9 Aug 2007

See all articles by Ravi Bansal

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

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Date Written: May 2007

Abstract

We argue that the cointegrating relation between dividends and consumption, a measure of long run consumption risks, is a key determinant of risk premia at all investment horizons. As the investment horizon increases, transitory risks disappear, and the asset's beta is dominated by long run consumption risks. We show that the return betas, derived from the cointegration-based VAR (EC-VAR) model, successfully account for the crosssectional variation in equity returns at both short and long horizons; this is not the case when the cointegrating restriction is ignored. Our evidence highlights the importance of cointegration-based long run consumption risks for financial markets.

Suggested Citation

Bansal, Ravi and Dittmar, Robert F. and Kiku, Dana, Cointegration and Consumption Risks in Asset Returns (May 2007). NBER Working Paper No. w13108, Available at SSRN: https://ssrn.com/abstract=986958

Ravi Bansal (Contact Author)

Duke University and NBER ( email )

Box 90120
Durham, NC 27708-0120
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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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