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Idiosyncratic risk and the equity premium: evidence from the Consumer Expenditure Survey

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  • Timothy Cogley
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    Abstract

    This paper uses household consumption data to investigate whether uninsurable idiosyncratic risk accounts for the equity premium. The analysis complements and extends prior empirical work by relaxing maintained assumptions about idiosyncratic income shocks. Following Mankiw (1986), the paper develops an equilibrium factor model in which risk premia depend on the covariance between an asset's return and certain moments of the cross-sectional distribution for consumption growth. Cross-sectional consumption factors are constructed using data from the Consumer Expenditure Survey, but they do not appear to be promising candidates for explaining the equity premium. Cross-sectional factors are very weakly correlated with stock returns, and generate equity premia of 1.5 percent or less when preference parameters are set at plausible values.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of San Francisco in its series Working Papers in Applied Economic Theory with number 98-07.

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    Date of creation: 1998
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    Handle: RePEc:fip:fedfap:98-07

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    Related research

    Keywords: Risk ; Consumption (Economics) ; Asset pricing;

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    Cited by:
    1. Martin Lettau, 2001. "Idiosyncratic risk and volatility bounds, or can models with idiosyncratic risk solve the equity premium puzzle?," Staff Reports 130, Federal Reserve Bank of New York.
    2. Laurian Lungu & Patrick Minford, 2006. "Explaining The Equity Risk Premium," Manchester School, University of Manchester, vol. 74(6), pages 670-700, December.

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