Consumption Strikes Back ? : Measuring Long-Run Risk 1

We characterize and measure a long-run risk-return tradeoff for the valuation of cash flows exposed to fluctuations in macroeconomic growth. This tradeoff features risk prices of cash flows that are realized far into the future but are reflected in asset values. We apply this analysis to claims on aggregate cash flows, as well as to cash flows from value and growth portfolios. Based on vector autoregressions, we characterize the dynamic response of cash flows to macroeconomic shocks and document that there are important differences in the long-run responses. We isolate those features of a recursive utility model and the consumption dynamics needed for the long-run valuation differences among these portfolios to be sizable. Finally, we show how the resulting measurements vary when we alter the statistical specifications of cash flows and consumption growth.

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