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Time-varying state variable risk premia in the ICAPM

Author

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  • Barroso, Pedro
  • Boons, Martijn
  • Karehnke, Paul
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.

Suggested Citation

  • Barroso, Pedro & Boons, Martijn & Karehnke, Paul, 2021. "Time-varying state variable risk premia in the ICAPM," Journal of Financial Economics, Elsevier, vol. 139(2), pages 428-451.
    • Handle: RePEc:eee:jfinec:v:139:y:2021:i:2:p:428-451
    DOI: 10.1016/j.jfineco.2020.07.016
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    3. Zhu, Haibin & Bai, Lu & He, Lidan & Liu, Zhi, 2023. "Forecasting realized volatility with machine learning: Panel data perspective," Journal of Empirical Finance, Elsevier, vol. 73(C), pages 251-271.
    4. Lim, Bryan & Sotes-Paladino, Juan & Wang, George Jiaguo & Yao, Yaqiong, 2024. "The value of growth: Changes in profitability and future stock returns," Journal of Banking & Finance, Elsevier, vol. 158(C).
    5. Rojo-Suárez, Javier & Alonso-Conde, Ana B. & Lago-Balsalobre, Rubén, 2024. "Industry bubbles and unexpected consumption shocks: A cross-sectional explanation of stock returns under recursive preferences," International Review of Economics & Finance, Elsevier, vol. 89(PA), pages 1156-1169.
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    More about this item

    Keywords

    Conditional asset pricing models; State variables; Intertemporal CAPM; Consumption predictability; Time-varying equity risk premia;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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