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Consumption Risk and the Cross Section of Expected Returns

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  • Jonathan A. Parker
  • Christian Julliard

Abstract

This paper evaluates the central insight of the Consumption Capital Asset Pricing Model (CCAPM) that an asset’s expected return is determined by its equilibrium risk to consumption. Rather than measure the risk of a portfolio by the contemporaneous covariance of its return and consumption growth — as done in the previous literature on the CCAPM and the pattern of crosssectional 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 explains little of the variation in observed average returns across the Fama and French 25 portfolios, ultimate consumption risk at a horizon of three years explains a large fraction of this variation.

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Bibliographic Info

Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 113 (2005)
Issue (Month): 1 (February)
Pages: 185-222

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Handle: RePEc:ucp:jpolec:v:113:y:2005:i:1:p:185-222

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