Cointegration and Consumption Risks in Asset Returns

Ravi Bansal; Robert Dittmar; Dana Kiku

doi:10.1093/rfs/hhm085

Cointegration and Consumption Risks in Asset Returns

Ravi Bansal¹; Robert Dittmar²; Dana Kiku^3,4

¹ Duke University · ² University of Michigan–Ann Arbor · ³ California University of Pennsylvania · ⁴ University of Pennsylvania

Review of Financial Studies 2009

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.

DOI: 10.1093/rfs/hhm085
Volume: 22 (3)
Pages: 1343-1375
Language: en
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