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Consumption Risk and the Cross-Section of Expected Returns

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Author Info
Jonathan A. Parker (Princeton University and NBER)
Christian Julliard (Princeton University)

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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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Publisher Info
Paper provided by Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics. in its series Working Papers with number 138.

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Date of creation: Mar 2004
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Handle: RePEc:pri:wwseco:138

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Related research
Keywords: Consumption Capital Asset Pricing Model; Expected returns; Equity premium; Consumption risk; Consumption smoothing;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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