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Consumption Risk and the Cross Section of Expected Returns

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  • Jonathan A. Parker
  • Christian Julliard

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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Suggested Citation

  • Jonathan A. Parker & Christian Julliard, 2005. "Consumption Risk and the Cross Section of Expected Returns," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 185-222, February.
  • Handle: RePEc:ucp:jpolec:v:113:y:2005:i:1:p:185-222
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    File URL: http://dx.doi.org/10.1086/426042
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    File URL: http://dx.doi.org/10.1086/426042
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    References listed on IDEAS

    as
    1. Hansen, Lars Peter & Jagannathan, Ravi, 1997. " Assessing Specification Errors in Stochastic Discount Factor Models," Journal of Finance, American Finance Association, vol. 52(2), pages 557-590, June.
    2. Fernando Alvarez & Andrew Atkeson & Patrick J. Kehoe, 2002. "Money, Interest Rates, and Exchange Rates with Endogenously Segmented Markets," Journal of Political Economy, University of Chicago Press, vol. 110(1), pages 73-112, February.
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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