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Time Variation in the Covariance between Stock Returns and Consumption Growth
Author(s) -
DUFFEE GREGORY R.
Publication year - 2005
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2005.00777.x
Subject(s) - covariance , stock (firearms) , econometrics , economics , conditional variance , capital asset pricing model , stock market , consumption (sociology) , financial economics , statistics , mathematics , autoregressive conditional heteroskedasticity , volatility (finance) , mechanical engineering , paleontology , social science , horse , sociology , engineering , biology
The conditional covariance between aggregate stock returns and aggregate consumption growth varies substantially over time. When stock market wealth is high relative to consumption, both the conditional covariance and correlation are high. This pattern is consistent with the “composition effect,” where agents' consumption growth is more closely tied to stock returns when stock wealth is a larger share of total wealth. This variation can be used to test asset‐pricing models in which the price of consumption risk varies. After accounting for variations in this price, the relation between expected excess stock returns and the conditional covariance is negative.