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

Grammig J, Schrimpf A, Schuppli M

Abstract
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 crosssection 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 riskaversion 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. © 2009 Taylor & Francis.