Working Paper: NBER ID: w13108
Authors: Ravi Bansal; Robert Dittmar; Dana Kiku
Abstract: We argue that the cointegrating relation between dividends and consumption, a measure of long run consumption risks, is a key determinant of risk premia at all investment horizons. As the investment horizon increases, transitory risks disappear, and the asset's beta is dominated by long run consumption risks. We show that the return betas, derived from the cointegration-based VAR (EC-VAR) model, successfully account for the crosssectional variation in equity returns at both short and long horizons; this is not the case when the cointegrating restriction is ignored. Our evidence highlights the importance of cointegration-based long run consumption risks for financial markets.
Keywords: cointegration; consumption risks; asset returns; risk premia
JEL Codes: C01; C13; G00; G1; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| cointegrating relation between dividends and consumption (D15) | risk premia (G22) |
| investment horizon increases (D15) | transitory risks fade (D15) |
| transitory risks fade (D15) | long-run consumption risks dominate asset's beta (D15) |
| cointegrating restriction ignored (C20) | ability of consumption-based models to explain risk premia deteriorates (D11) |
| error-correction term included in cointegration relation (C22) | predict variation in future returns (G17) |
| market price of consumption risks remains positive and significant across horizons (D11) | risk premia (G22) |
| long-run consumption risks (D15) | dominant source of risk premia (G11) |
| conditional consumption betas (D11) | information about risk premia (G12) |