Asset Pricing with Countercyclical Household Consumption Risk

Abstract

We show that shocks to household consumption growth are negatively skewed, persistent, countercyclical, and drive asset prices.We construct a parsimonious model where heterogeneous households have recursive preferences.A single state variable drives the conditional crosssectional moments of household consumption growth.The estimated model fits well the unconditional cross-sectional moments of household consumption growth and the moments of the risk-free rate, equity premium, price-dividend ratio, and aggregate dividend and consumption growth.The model-implied risk-free rate and price-dividend ratio are procyclical while the market return has countercyclical mean and variance.Finally, household consumption risk explains the cross-section of excess returns.

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