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Time-varying state variable risk premia in the ICAPM

Pedro Barroso (), Martijn Boons and Paul Karehnke

Journal of Financial Economics, 2021, vol. 139, issue 2, 428-451

Abstract: We find that the relation between state variables, such as the t-bill rate and term spread, and consumption growth is time-varying. In the cross-section of U.S. stocks, risk premia for exposure to state variables vary over time accordingly. When a state variable predicts consumption strongly relative to its own history, its annualized risk premium increases by 6% (0.4 in Sharpe ratio). This effect implies that risk premia can switch signs and are increasing in the conditional variance of the state variable. These common drivers of time-varying risk premia are consistent with the Intertemporal CAPM. Benchmark factors contain the same conditional expected return effects as state variable risk premia.

Keywords: Conditional asset pricing models; State variables; Intertemporal CAPM; Consumption predictability; Time-varying equity risk premia (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.jfineco.2020.07.016

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