Abstract
In this paper we extend the concept of ultimate consumption risk analyzed by Parker and Julliard (Journal of Political Economy, 2005), and we evaluate the Consumption Capital Asset Pricing Model by employing as an explanatory variable consumption risk over the frequency domain. We find that at lower frequencies consumption risk explains up to 98% of the cross-sectional variation of expected returns and the equity premium puzzle is resolved. Our evidence is consistent with a coefficient of risk aversion between 1 and 4 in the very long run.
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