NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Consumption Risk and the Cost of Equity Capital

Ravi Jagannathan, Yong Wang

NBER Working Paper No. 11026
Issued in January 2005
NBER Program(s):   AP

We demonstrate, using data for the period 1954-2003, that differences in exposure to consumption risk explains cross sectional differences in average excess returns (cost of equity capital) across the 25 benchmark equity portfolios constructed by Fama and French (1993). We use yearly returns on stocks to take into account well documented within year deterministic seasonal patterns in returns, measurement errors in the consumption data, and possible slow adjustment of consumption to changes in wealth due to habit and prior commitments. Consumption during the fourth quarter is likely to have a larger discretionary component. Further, given the availability of more leisure time during the holiday season and the ending of the tax year in December, investors are more likely to review their asset holdings and make trading decisions during the fourth quarter. We therefore match the growth rate in the fourth quarter consumption from one year to the next with the corresponding calendar year return when computing the latter's exposure to consumption risk. We find strong support for our consumption risk model specification in the data.

download in pdf format
   (286 K)

email paper

This paper is available as PDF (286 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w11026

Forthcoming in the August 2007 issue of the Journal of Finance under the title, "Lazy Investors, Discretionary Consumption, and the Cross Section of Stock Returns."

Users who downloaded this paper also downloaded these:
Da, Guo, and Jagannathan w14889 CAPM for Estimating the Cost of Equity Capital: Interpreting the Empirical Evidence
Stulz w7021 Globalization of Equity Markets and the Cost of Capital
Pastor and Stambaugh w6490 Costs of Equity Capital and Model Mispricing
Cohen, Polk, and Vuolteenaho w11018 Money Illusion in the Stock Market: The Modigliani-Cohn Hypothesis
Parker w9548 Consumption Risk and Expected Stock Returns
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us