We find that several recently proposed consumption‐based models of stock returns, when evaluated using an optimal set of managed portfolios and the associated model‐implied conditional moment restrictions, fail to capture key features of risk premiums in equity markets. To arrive at these conclusions, we construct an optimal Generalized Method of Moments (GMM) estimator for models in which the stochastic discount factor (SDF) is a conditionally affine function of a set of priced risk factors, and we show that there is an optimal choice of managed portfolios to use in testing a null model against a proposed alternative generalized SDF.

Agency theory and optimal contracting theory posit opposing roles and shareholder wealth effects for corporate inside directors. We evaluate these theories using the market for outside directorships to differentiate among inside directors. Firms with inside directors holding outside directorships have better operating performance and market‐to‐book ratios, especially when monitoring is more difficult. These firms make better acquisition decisions, have greater cash holdings, and overstate earnings less often. Announcements of outside board appointments improve shareholder wealth, while departure announcements reduce it, consistent with these inside directors improving board performance and outside directorships being an important source of inside director incentives.

We explicitly consider financial leverage in a simple equity valuation model and study the cross‐sectional implications of potential shareholder recovery upon resolution of financial distress. Our model is capable of simultaneously explaining lower returns for financially distressed stocks, stronger book‐to‐market effects for firms with high default likelihood, and the concentration of momentum profits among low credit quality firms. The model further predicts (i) a hump‐shaped relationship between value premium and default probability, and (ii) stronger momentum profits for nearly distressed firms with significant prospects for shareholder recovery. Our empirical analysis strongly confirms these novel predictions.

A new measure of consumption, garbage, is more volatile and more correlated with stocks than the canonical measure, National Income and Product Accounts (NIPA) consumption expenditure. A garbage‐based consumption capital asset pricing model matches the U.S. equity premium with relative risk aversion of 17 versus 81 and evades the joint equity premium‐risk‐free rate puzzle. These results carry through to European data. In a cross‐section of size, value, and industry portfolios, garbage growth is priced and drives out NIPA expenditure growth.