NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Consumption Risk and Expected Stock Returns

Jonathan A. Parker

NBER Working Paper No. 9548
Issued in March 2003
NBER Program(s):   ME   AP

Following the textbook C-CAPM, the consumption risk of an asset is typically measured as the contemporaneous covariance of the marginal utility of consumption and the return on that asset. When measured this way, consumption risk is too small to explain the observed equity premium, is negatively related to expected excess returns over time, and fails to explain the cross-sectional differences in average returns of the Fama and French (25) portfolios. This paper evaluates the central insight of the C-CAPM - that consumption risk determines returns - but take the model less literally by allowing the possibility that households do not instantaneously and completely adjust consumption to the news revealed about wealth in a period. The long-term consumption risk of the aggregate market is signficantly larger than the contemporaneous risk and is positively related to expected excess returns over time. The long-term consumption risk of different portfolios largely explains the observed differences in average returns.

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Document Object Identifier (DOI): 10.3386/w9548

Published: Parker, Jonathan A. "Consumption Risk And Expected Stock Returns," American Economic Review, 2003, v93(2,May), 376-382. citation courtesy of

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