 Procyclicality of the comovement between dividend growth and consumption growthNancy R. Xu Journal of Financial Economics, 2021, vol. 139, issue 1, 288-312 Abstract: Duffee (2005) shows that the amount of consumption risk (i.e., the conditional covariance between market returns and consumption growth) is procyclical. In light of this “Duffee Puzzle,” I empirically demonstrate that the conditional covariance between dividend growth (i.e., the immediate cash flow part of market returns) and consumption growth is (1) procyclical and (2) a consistent source of procyclicality in the puzzle. Moreover, I solve an external habit formation model that incorporates realistic joint dynamics of dividend growth and consumption growth. The procyclical dividend-consumption comovement entails two new procyclical terms in the amount of consumption risk via cash flow and valuation channels, respectively. These two procyclical terms play an important role in generating a realistic magnitude of consumption risk. In contrast to extant habit formation models, the conditional equity premium no longer increases monotonically when a negative consumption shock arrives because it might lower the amount of risk while increasing the price of risk. Keywords: Duffee Puzzle; Procyclical amount of consumption risk; Dividend-consumption comovement; Habit formation; Equity premium (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:139:y:2021:i:1:p:288-312 DOI: 10.1016/j.jfineco.2020.07.013 Access Statistics for this article Journal of Financial Economics is currently edited by G. William Schwert More articles in Journal of Financial Economics from Elsevier |
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