Asset Pricing with Countercyclical Household Consumption Risk

Asset Pricing with Countercyclical Household Consumption Risk

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Article ID: iaor201710
Volume: 72
Issue: 1
Start Page Number: 415
End Page Number: 460
Publication Date: Feb 2017
Journal: The Journal of Finance
Authors: ,
Keywords: economics, risk, simulation
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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