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Consumption risk and cross-sectional returns

Parker, Jonathan A. and Julliard, Christian (2003) Consumption risk and cross-sectional returns. 9538. National Bureau of Economic Research, Cambridge, MA., USA.

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Identification Number: 9538

Abstract

This paper evaluates the central insight of the Consumption Capital Asset Pricing Model (C-CAPM) that an asset's expected return is determined by its equilibrium risk to consumption. Rather that measure the risk of a portfolio by the contemporaneous covariance of its return and consumption growth -- as done in the previous literature on the C-CAPM and the pattern of cross-sectional returns -- we measure the risk of a portfolio by its ultimate consumption risk defined as the covariance of its return and consumption growth over the quarter of the return and many following quarters. While contemporaneous consumption risk has little predictive power for explaining the pattern of average returns across the Fama and French (25) portfolios, ultimate consumption risk is highly statistically significant in explaining average returns and explains a large fraction of the variation in average returns. Aditionally, estimates of the average risk-free real rate of interest and the coefficient of relative risk aversion of the representative household based on ultimate consumption risk are more reasonable than those obtained using contemporaneous consumption risk.

Item Type: Monograph (Working Paper)
Official URL: http://www.nber.org
Additional Information: © 2003 Jonathan A. Parker and Christian Julliard
Subjects: H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
Departments > Economics
Collections > LSE Financial Markets Group (FMG) Working Papers
Date Deposited: 09 May 2008 16:22
Last Modified: 27 Feb 2014 15:36
URI: http://eprints.lse.ac.uk/id/eprint/4810

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