Long-horizon consumption risk and the cross-section of returns: new tests and international evidence

This paper investigates whether measuring consumption risk over long horizons can improve the empirical performance of the consumption-based capital asset pricing model (CCAPM) for size and value premia in international stock markets (USA, UK, and Germany). In order to account for commonalities in size and book-to-market sorted portfolios, we also include industry portfolios in our set of test assets. Our results show that, contrary to the findings of Parker and Julliard [2005. Consumption risk and the cross- section of expected returns. Journal of Political Economy 113, no. 1: 185-222], the model falls short of providing an accurate description of the cross-section of returns under our modified empirical approach. At the same time, however, measuring consumption risk over longer horizons typically yields lower risk-aversion estimates. Thus, our results suggest that more plausible parameter estimates - as opposed to lower pricing errors - can be regarded as the main achievement of the long-horizon CCAPM.