Article2016

Asset Pricing with Countercyclical Household Consumption Risk

116 citations0/0 files storedThe Journal of Finance

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Financial Markets and Investment Strategies Stochastic processes and financial applications Economic theories and models

Abstract

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 cross‐sectional 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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References

1993Common risk factors in the returns on stocks and bonds 1973Risk, Return, and Equilibrium: Empirical Tests 1985A Theory of the Term Structure of Interest Rates 1989Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework 1988The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors 2000Conditional Skewness in Asset Pricing Tests 1986The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors 2006Rare Disasters and Asset Markets in the Twentieth Century*

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