Consumption Volatility Risk

While many papers test consumption-based pricing models using the first moment of consumption growth, less is known about how the time-variation of consumption growth volatility affects asset prices. In a model with recursive preferences and unobservable conditional mean and volatility of consumption growth, the representative agent's estimates of conditional moments of consumption growth affect excess returns. Empirically, we find that estimated consumption volatility is a priced source of risk and exposure to it predicts future returns in the cross-section. Consumption volatility is also a strong predictor of aggregate quarterly excess returns in the time-series.