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Using Long-Run Consumption-Return Correlations to Test Asset Pricing Models

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  • Jianfeng Yu

    (University of Minnesota)

Abstract

This paper examines a new set of implications for existing asset pricing models regarding the correlation between returns and consumption growth over both the short run and the long run. The findings suggest that external habit formation models face a challenge in producing two robust facts in aggregate data, namely, that stock market returns lead consumption growth, and that the correlation between returns and consumption growth is higher at low frequencies. To reconcile these facts with a consumption-based model, I demonstrate the need for focusing on models that contain a forward looking consumption component, i.e., models that allow for both trend and cyclical fluctuations in consumption, and that link returns to cyclical fluctuations in consumption. Long-run risk models provide examples of models that contain this consumption component. (Copyright: Elsevier)

Suggested Citation

  • Jianfeng Yu, 2012. "Using Long-Run Consumption-Return Correlations to Test Asset Pricing Models," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(3), pages 317-335, October.
  • Handle: RePEc:red:issued:10-230 DOI: 10.1016/j.red.2012.04.001
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    References listed on IDEAS

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    Cited by:

    1. Michael McAleer & Christian M. Hafner, 2014. "A One Line Derivation of EGARCH," Econometrics, MDPI, Open Access Journal, pages 1-6.

    More about this item

    Keywords

    Long-run risk; Forward-looking;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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