Time-varying state variable risk premia in the ICAPM

Pedro Barroso, Martijn Boons*, Paul Karehnke

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

Abstract

We find that the relation between state variables, such as the t-bill rate and term spread, and consumption growth is time-varying. In the cross-section of U.S. stocks, risk premia for exposure to state variables vary over time accordingly. When a state variable predicts consumption strongly relative to its own history, its annualized risk premium increases by 6% (0.4 in Sharpe ratio). This effect implies that risk premia can switch signs and are increasing in the conditional variance of the state variable. These common drivers of time-varying risk premia are consistent with the Intertemporal CAPM. Benchmark factors contain the same conditional expected return effects as state variable risk premia. (C) 2020 Elsevier B.V. All rights reserved.
Original languageEnglish
Pages (from-to)428-451
Number of pages24
JournalJournal of Financial Economics
Volume139
Issue number2
DOIs
Publication statusPublished - Feb 2021

Keywords

  • Conditional asset pricing models
  • State variables
  • Intertemporal CAPM
  • Consumption predictability
  • Time-varying equity risk premia
  • CROSS-SECTION
  • CONDITIONAL CAPM
  • STOCK RETURNS
  • ASSET
  • CONSUMPTION
  • VOLATILITY
  • INFORMATION
  • PERFORMANCE

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