Abstract
Financial intermediary economic growth theory with its empirical findings, along with stock-level factors; both ideally relate to a consumption asset pricing model. Changing liquidity and earnings combined with the market proxy wealth growth, allowing a recursive consumption model with a low risk aversion coefficient, a risk-free rate close to historical, a high equity premium, and a reasonable elasticity of intertemporal substitution. The empirical consumption model does well against major asset pricing puzzles. Tested over 118 years it is not rejected while a forward-looking consumption model using the market alone as a wealth proxy fails. Changing liquidity and earnings forecast consumption and their ‘crashes’ precede consumption declines. This consistency across approaches adds credence to common risk factors as important risks to investors.
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