IDEAS home Printed from
   My bibliography  Save this article

Expected Returns and the Business Cycle: Heterogeneous Goods and Time-Varying Risk Aversion


  • Lars A. Lochstoer


This paper proposes a representative agent habit-formation model where preferences are defined for both luxury goods and basic goods. The model matches the equity risk premium, risk-free rate, and volatilities. From the intratemporal first-order condition, one can substitute out basic good consumption and the habit level, yielding a stochastic discount factor driven by two observable risk factors: luxury good consumption and the relative price of the two goods. I estimate these processes and find them to be heteroskedastic, implying time variation in the conditional volatility of the stochastic discount factor. These dynamics occur both at the business cycle frequency and at a lower, "generational" frequency. The findings reveal that the time variation in aggregate stock market and Treasury bond risk premiums are consistent with the predictions of the model. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email:, Oxford University Press.

Suggested Citation

  • Lars A. Lochstoer, 2009. "Expected Returns and the Business Cycle: Heterogeneous Goods and Time-Varying Risk Aversion," Review of Financial Studies, Society for Financial Studies, vol. 22(12), pages 5251-5294, December.
  • Handle: RePEc:oup:rfinst:v:22:y:2009:i:12:p:5251-5294

    Download full text from publisher

    File URL:
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to search for a different version of it.


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Jessica A. Wachter & Motohiro Yogo, 2010. "Why Do Household Portfolio Shares Rise in Wealth?," Review of Financial Studies, Society for Financial Studies, vol. 23(11), pages 3929-3965, November.
    2. Yuk Ying Chang & Martin Young, 2016. "Brand Firm Performance and Tough Economic Times," International Review of Finance, International Review of Finance Ltd., vol. 16(3), pages 357-391, September.
    3. Ehling, Paul & Heyerdahl-Larsen, Christian, 2015. "Complete and incomplete financial markets in multi-good economies," Journal of Economic Theory, Elsevier, vol. 160(C), pages 438-462.

    More about this item


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oup:rfinst:v:22:y:2009:i:12:p:5251-5294. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Oxford University Press) or (Christopher F. Baum). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.