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Cointegration and Consumption Risks in Asset Returns

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  • Ravi Bansal
  • Robert Dittmar
  • Dana Kiku

Abstract

We argue that the cointegrating relation between dividends and consumption, a measure of long run consumption risks, is a key determinant of risk premia at all investment horizons. As the investment horizon increases, transitory risks disappear, and the asset's beta is dominated by long run consumption risks. We show that the return betas, derived from the cointegration-based VAR (EC-VAR) model, successfully account for the crosssectional variation in equity returns at both short and long horizons; this is not the case when the cointegrating restriction is ignored. Our evidence highlights the importance of cointegration-based long run consumption risks for financial markets.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13108.

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Date of creation: May 2007
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Publication status: published as Ravi Bansal & Robert Dittmar & Dana Kiku, 2009. "Cointegration and Consumption Risks in Asset Returns," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 22(3), pages 1343-1375, March.
Handle: RePEc:nbr:nberwo:13108

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