A consumption-based explanation of expected stock returns

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273 Scopus citations


When utility is nonseparable in nondurable and durable consumption and the elasticity of substitution between the two consumption goods is sufficiently high, marginal utility rises when durable consumption falls. The model explains both the cross-sectional variation in expected stock returns and the time variation in the equity premium. Small stocks and value stocks deliver relatively low returns during recessions, when durable consumption falls, which explains their high average returns relative to big stocks and growth stocks. Stock returns are unexpectedly low at business cycle troughs, when durable consumption falls sharply, which explains the countercyclical variation in the equity premium.

Original languageEnglish (US)
Pages (from-to)539-580
Number of pages42
JournalJournal of Finance
Issue number2
StatePublished - Apr 2006
Externally publishedYes

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics


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