Industry bubbles and unexpected consumption shocks: A cross-sectional explanation of stock returns under recursive preferences

Javier Rojo-Suárez, Ana B. Alonso-Conde and Rubén Lago-Balsalobre

International Review of Economics & Finance, 2024, vol. 89, issue PA, 1156-1169

Abstract: Assuming an environment with rational and informed agents, where investors exhibit recursive preferences and make their economic decisions embedding industry bubbles into their information sets, we study to what extent unexpected consumption shocks can proxy for revisions in expected consumption growth and, consequently, explain the cross-sectional behavior of stock returns. Our results show that unexpected consumption shocks help forecast future consumption growth, allowing the Epstein-Zin model to satisfactorily explain the equity risk premium of different anomaly portfolios on the Tokyo Stock Exchange. Furthermore, our model provides a better understanding on the dynamics of consumption and its relationship to stock returns.

Keywords: Recursive preferences; Consumption shocks; Industry bubbles; Investment-capital ratio; Consumption-CAPM (search for similar items in EconPapers)
JEL-codes: E32 E44 G12 G15 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:89:y:2024:i:pa:p:1156-1169

DOI: 10.1016/j.iref.2023.07.086

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