Article2007

Cointegration and Consumption Risks in Asset Returns

Ravi Bansal · Robert F. Dittmar · Dana Kiku

170 citations0/0 files storedReview of Financial Studies

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Financial Markets and Investment Strategies Financial Analysis and Corporate Governance Financial Risk and Volatility Modeling

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 cross-sectional variation in equity returns at both short and long horizons; however, 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.

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References

1987Co-Integration and Error Correction: Representation, Estimation, and Testing 1993Common risk factors in the returns on stocks and bonds 1999By Force of Habit: A Consumption‐Based Explanation of Aggregate Stock Market Behavior 1978Asset Prices in an Exchange Economy 2000Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles 1979An intertemporal asset pricing model with stochastic consumption and investment opportunities 1996The Conditional CAPM and the Cross-Section of Expected Returns 1988Stock Prices, Earnings, and Expected Dividends

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