Long-Run Stockholder Consumption Risk and Asset Returns

by Christopher J. Malloy, Tobias J. Moskowitz & Annette Vissing-Jørgensen

Overview — The long-run consumption risk of households that hold financial assets is particularly relevant for asset pricing. The fact that stockholders are more sensitive to aggregate consumption movements helps explain why the consumption risk of stockholders delivers lower risk aversion estimates. Understanding further why consumption growth, particularly that of stockholders, responds slowly to news in asset returns will improve finance scholars' understanding of what drives these long-run relations. HBS professor Malloy and his coauthors examine more disaggregated measures of long-run consumption risks across stockholders and non-stockholders, and provide new evidence on the long-run properties of consumption growth and its importance for asset pricing. Key concepts include:

Small and value stocks earn low returns, and long-term bonds do poorly when the future consumption growth of stockholders is low.
The high average returns observed for small and value stocks and long-maturity bonds may therefore reflect the premium stockholders require to bear long-run consumption risk.

Author Abstract

We provide new evidence on the success of long-run risks in asset pricing by focusing on the risks borne by stockholders. Exploiting micro-level household consumption data, we show that long-run stockholder consumption risk better captures cross-sectional variation in average asset returns than aggregate or non-stockholder consumption risk, and provides more plausible economic magnitudes. We find that risk aversion estimates around 10 can match observed risk premia for the wealthiest stockholders across sets of test assets that include the 25 Fama and French size and value portfolios, the market portfolio, bond portfolios, and the entire cross-section of stocks.