Abstract
We find that the relation between state variables, such as the t-bill rate and term spread, and consumption growth is time-varying. In the cross-section of U.S. stocks, risk premia for exposure to state variables vary over time accordingly. When a state variable predicts consumption strongly relative to its own history, its annualized risk premium increases by 6% (0.4 in Sharpe ratio). This effect implies that risk premia can switch signs and are increasing in the conditional variance of the state variable. These common drivers of time-varying risk premia are consistent with the Intertemporal CAPM. Benchmark factors contain the same conditional expected return effects as state variable risk premia.
Original language | English |
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Pages (from-to) | 428-451 |
Journal | Journal of Financial Economics |
Volume | 139 |
Issue number | 2 |
DOIs | |
Publication status | Published - Feb 2021 |
Keywords
- Conditional asset pricing models
- Consumption predictability
- Intertemporal CAPM
- State variables
- Time-varying equity risk premia