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Consumption Risk and Expected Stock Returns
January 2003
Following the textbook CCAPM, 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 di.erences in average returns
of the Fama and French (25) portfolios. This paper evaluates the central insight of the
CCAPM -- 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, is positively related to expected excess returns over time, and is highly correlated
with the cross-sectional di.erences in average returns of the Fama and French (25)
portfolios.
The paper from the NBER
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