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RFS Advance Access originally published online on December 20, 2007
Review of Financial Studies 2009 22(3):1343-1375; doi:10.1093/rfs/hhm085
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© The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Cointegration and Consumption Risks in Asset Returns

Ravi Bansal
Duke University and NBER

Robert Dittmar
University of Michigan

Dana Kiku
University of Pennsylvania

Address correspondence to Ravi Bansal, Fuqua School of Business, Duke University, Durham, NC 27708; telephone: 919-660-7758; e-mail: ravi.bansal{at}duke.edu.

JEL Classification: G1, G12


  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.

An earlier draft of this paper was circulated with the title "Long-Run Risks and Equity Returns." We would like to thank Lars Hansen, George Tauchen, Jessica Wachter, Vivian Wang, Amir Yaron, and the seminar participants at Arizona State University, Duke University, Simon Fraser University, Stanford University, University of British Columbia, University of Michigan, University of North Carolina, University of Pennsylvania, Vanderbilt University, Federal Reserve Board of Governors Conference on Risk Premiums: Time Variation and Macroeconomic Links, and 2007 American Finance Association Meetings for helpful comments. The usual disclaimer applies.


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