Consumption Risk and Expected Stock Returns

Jonathan Parker

No 9548, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Following the textbook C-CAPM, the consumption risk of an asset is typically measured as the contemporaneous covariance of the marginal utility of consumption and the return on that asset. When measured this way, consumption risk is too small to explain the observed equity premium, is negatively related to expected excess returns over time, and fails to explain the cross-sectional differences in average returns of the Fama and French (25) portfolios. This paper evaluates the central insight of the C-CAPM - that consumption risk determines returns - but take the model less literally by allowing the possibility that households do not instantaneously and completely adjust consumption to the news revealed about wealth in a period. The long-term consumption risk of the aggregate market is signficantly larger than the contemporaneous risk and is positively related to expected excess returns over time. The long-term consumption risk of different portfolios largely explains the observed differences in average returns.

JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2003-03
New Economics Papers: this item is included in nep-cfn
Note: ME AP
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Citations: View citations in EconPapers (21)

Published as Parker, Jonathan A. "Consumption Risk And Expected Stock Returns," American Economic Review, 2003, v93(2,May), 376-382.

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