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Industry bubbles and unexpected consumption shocks: A cross-sectional explanation of stock returns under recursive preferences

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  • Rojo-Suárez, Javier
  • Alonso-Conde, Ana B.
  • Lago-Balsalobre, Rubén

Abstract

Assuming an environment with rational and informed agents, where investors exhibit recursive preferences and make their economic decisions embedding industry bubbles into their information sets, we study to what extent unexpected consumption shocks can proxy for revisions in expected consumption growth and, consequently, explain the cross-sectional behavior of stock returns. Our results show that unexpected consumption shocks help forecast future consumption growth, allowing the Epstein-Zin model to satisfactorily explain the equity risk premium of different anomaly portfolios on the Tokyo Stock Exchange. Furthermore, our model provides a better understanding on the dynamics of consumption and its relationship to stock returns.

Suggested Citation

  • Rojo-Suárez, Javier & Alonso-Conde, Ana B. & Lago-Balsalobre, Rubén, 2024. "Industry bubbles and unexpected consumption shocks: A cross-sectional explanation of stock returns under recursive preferences," International Review of Economics & Finance, Elsevier, vol. 89(PA), pages 1156-1169.
    • Handle: RePEc:eee:reveco:v:89:y:2024:i:pa:p:1156-1169
    DOI: 10.1016/j.iref.2023.07.086
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    More about this item

    Keywords

    Recursive preferences; Consumption shocks; Industry bubbles; Investment-capital ratio; Consumption-CAPM;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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