Cointegration and consumption risks in asset returns

Ravi Bansal, Robert Dittmar, Dana Kiku

Research output: Contribution to journalArticlepeer-review

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 cross-sectional variation in equity returns at both short and long horizons; however, 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.

Original languageEnglish (US)
Pages (from-to)1343-1375
Number of pages33
JournalReview of Financial Studies
Volume22
Issue number3
DOIs
StatePublished - Mar 2009
Externally publishedYes

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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