Expected Consumption Growth Research Articles

Salience effect and yield curve

This paper studies the influence of salience on nominal and real yield curves by introducing the salience effect in the Piazzesi and Schneider model (hereafter PS). We construct the salience values based on the expected consumption growth using U.S. data. We find that salience values are negatively correlated with the expected consumption growth rates. Based on U.S. data from 1960q1 to 2020q4, we find that the salience model can generate upward nominal and real yield curves within reasonable risk aversion coefficients (less than 10), as well as well-fitted average yields with actual data. The salience model compensates for the PS or recursive preference model’s inability to generate an upward nominal or real yield curve within reasonable risk aversion. Furthermore, we provide empirical support for model implications.

Industry bubbles and unexpected consumption shocks: A cross-sectional explanation of stock returns under recursive preferences

Assuming an environment with rational and informed agents, where investors exhibit recursive preferences and make their economic decisions embedding industry bubbles into their information sets, we study to what extent unexpected consumption shocks can proxy for revisions in expected consumption growth and, consequently, explain the cross-sectional behavior of stock returns. Our results show that unexpected consumption shocks help forecast future consumption growth, allowing the Epstein-Zin model to satisfactorily explain the equity risk premium of different anomaly portfolios on the Tokyo Stock Exchange. Furthermore, our model provides a better understanding on the dynamics of consumption and its relationship to stock returns.

Consumption and income expectations during Covid-19

Using a survey of Italian households administered in November 2021, we study the effect of microeconomic and macroeconomic expectations about the health crisis and income growth on consumption expectations in 2022. The survey elicits individual-level indicators of income and consumption expectations, distinguishing between consumption at home, away from home, online and total. We find that expected household income and expected GDP growth are strongly related to consumption expectations; income risk is positively associated with expected consumption growth for richer households. Finally, our results indicate that health-related variables were not a major drivers of consumption expectations in 2022.

Extreme Inflation and Time-Varying Expected Consumption Growth

In a parsimonious regime switching model, we find strong evidence that expected consumption growth varies over time. Adding inflation as a second variable, we uncover two states in which expected consumption growth is low, one with high and one with negative expected inflation. Embedded in a general equilibrium asset pricing model with learning, these dynamics replicate the observed time variation in stock return volatilities and stock-bond return correlations. They also provide an alternative derivation for a measure of time-varying disaster risk suggested by Watcher [ Wachter J (2013 ) Can time-varying risk of rare disasters explain aggregate stock market volatility? J. Finance 68(3):987–1035]. implying that both the disaster and the long-run risk paradigm can be extended toward explaining movements in the stock-bond correlation. This paper was accepted by Kay Giesecke, finance. Funding: We gratefully acknowledge research and financial support from the Leibniz Center for Financial Research SAFE (formerly Research Center SAFE, funded by the State of Hessen initiative for research LOEWE). Supplemental Material: The data files and online appendices are available at https://doi.org/10.1287/mnsc.2022.4451 .

Extreme Inflation and Time-Varying Expected Consumption Growth

Extreme Inflation and Time-Varying Expected Consumption Growth

Subjective intertemporal substitution

Using subjective expectations data from the New York Fed’s Survey of Consumer Expectations (SCE), we estimate the elasticity of intertemporal substitution (EIS)—the response of expected consumption growth to changes in the real interest rate. This unique data set allows us to estimate the consumption Euler equation with no auxiliary assumptions on the properties of expectations, which are instead necessary when using choice data. We find a subjective EIS of about 0.5, consistent with the results of much of the literature. In addition, planned consumption displays excess sensitivity to expected income changes, even among households not facing substantial liquidity constraints.

Bayesian estimation of long-run risk models using sequential Monte Carlo

We propose a likelihood-based Bayesian method that exploits up-to-date sequential Monte Carlo methods to efficiently estimate long-run risk models in which the conditional variance of consumption growth follows either an autoregressive (AR) process or an autoregressive gamma (ARG) process. We use the U.S. quarterly consumption and asset returns data from the postwar period to implement estimation. Our findings are: (1) informative priors on the preference parameters can help to improve model performance; (2) expected consumption growth has a very persistent component, whereas consumption volatility is less persistent; (3) while the ARG-based model performs better than the AR-based one statistically, the latter could fit asset returns better; and (4) the solution method matters more for estimation in the AR-based model than in the ARG-based model.

Estimating and Testing Long-Run Risk Models: International Evidence

We estimate and test long-run risk models using international macroeconomic and financial data. The benchmark model features a representative agent who has recursive preferences with a time preference shock, a persistent component in expected consumption growth, and stochastic volatility in fundamentals characterized by an autoregressive Gamma process. We construct a comprehensive dataset with quarterly frequency in the post-war period for ten developed countries and employ an efficient likelihood-based Bayesian method that exploits up-to-date sequential Monte Carlo methods to make full econometric inference. Our estimation provides international evidence in support of long-run risks, time-varying preference shocks, and countercyclicality of the stochastic discount factor.

Bayesian Estimation of Long-Run Risk Models Using Sequential Monte Carlo

We propose a likelihood-based Bayesian method that exploits up-to-date sequential Monte Carlo methods to efficiently estimate long-run risk models in which the conditional variance of consumption growth follows either an autoregressive (AR) process or an autoregressive gamma (ARG) process. We use the U.S. quarterly consumption and asset returns data from the postwar period to implement estimation. Our findings are: (1) informative priors on the preference parameters can help to improve model performance; (2) expected consumption growth has a very persistent component, whereas consumption volatility is less persistent; (3) while the ARG-based model performs better than the AR-based one statistically, the latter could fit asset returns better; and (4) the solution method matters more for estimation in the AR-based model than in the ARG-based model.

Consumption Uncertainty and Precautionary Saving

Using survey data from a representative sample of Dutch households, we estimate the strength of precautionary saving by eliciting subjective expectations on future consumption. Expected consumption risk is positively correlated with self-employment and income risk and negatively with age. We insert these subjective expectations (rather than consumption realizations, as in the existing literature) in an Euler equation for consumption and estimate the degree of prudence by associating expected consumption risk with expected consumption growth. Robust OLS and IV estimates indicate a coefficient of relative prudence of around 2. We obtain similar results via partial identification methods using weak assumptions.

Industry bubbles and the cross‐sectional variation of expected consumption growth

AbstractWe study the relationship between the domestic consumption growth and industry bubbles, under the assumption that, at a global level, the bubbles created by productive countries totally or partially offset the bubbles created by unproductive countries. Using a methodology based on a time‐varying parameter vector autoregression, we define the expected consumption growth as a function of the exposure to bubbly episodes and the price of bubbles, among other variables. We test the model for nine European countries. Our results show that the variation of construction and technology bubbles has a strong explanatory power for the domestic consumption growth.

Planetary boundaries of consumption growth: Declining social discount rates

We introduce the logistic model of consumption growth, which captures a negative feedback preventing an unlimited growth of consumption due to finite biophysical resources of our planet. This simple dynamic model allows for derivation of the expression describing the declining long-term tail of a social discount curve. The latter plays a critical role in, e.g., climate finance with benefits on current investments deferred to centuries from now. The growth rate of consumption is irregularly evolving in time, which makes estimation of an expected term-structure of consumption growth and associated social discount rates a challenging task. Nonetheless, observations show that the problem at hand is perturbative with the small parameter being the product of an average strength of fluctuations in the growth rate and its autocorrelation time. This fact permits utilization of the cumulant expansion method to derive remarkably simple expressions for the term-structure of expected consumption growth and associated discount rates in the bounded economy. We demonstrate that the dynamic effect related to the planetary resource constrains could become a dominant mechanism responsible for a declining long-term tail of a social discount curve in a distant future. The derived results can help to shape a more realistic long-term social discounting policy. Furthermore, with the obvious redefinition of the key parameters of the model, obtained results are directly applicable for description of expected long-term population growth in stochastic environments.

Consumption Risk and the Cross-Section of Option Returns

We offer evidence that exposures to consumption growth, expected consumption growth, and consumption volatility are significantly priced in the cross-section of delta-hedged option and straddle returns. Consumption growth and expected consumption growth command a positive risk premium, whereas consumption volatility commands a negative risk premium. In a representative-agent economy with recursive preferences, our results suggest that investors prefer early resolution of uncertainty. Our results further suggest that consumption risk exposures provide rational foundations for well-known relations between option moneyness or idiosyncratic underlying-stock volatility and the cross-section of delta-hedged option or straddle returns.

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Extreme Inflation and Time-Varying Consumption Growth

In a parsimonious regime switching model, expected consumption growth varies over time. Adding in ation as a conditioning variable, we uncover two states in which expected consumption growth is low, one with high and one with negative expected in ation. Embedded in a general equilibrium asset pricing model with learning, these dynamics replicate the observed time variation in stock return volatilities and stock-bond return correlations. Furthermore, they provide an alternative way to come up with a measure of time-varying disaster risk in the spirit of Wachter (2013). Our findings imply that both the disaster and the long-run risk paradigm can be extended towards explaining movements in the stock-bond return correlation.

The Real Term Premium in a Stationary Economy with Segmented Asset Markets

This article proposes a general equilibrium model to explain the positive and sizable term premia implied by the data. The authors introduce a slow mean-reverting process of consumption growth and a segmented asset-market mechanism with heterogeneous trading technologies into an otherwise standard heterogeneous agent general equilibrium model. First, the slow mean-reverting consumption growth process implies that the expected consumption growth rate is only slightly countercyclical and the process can exhibit near-zero first-order autocorrelation, as observed in the data. This slight countercyclicality suggests that long-term bonds are risky, and hence the term premia should be positive. Second, the segmented asset-market mechanism amplifies the magnitude of the term premia because aggregate risk is highly concentrated in a small fraction of marginal traders who demand high compensation for taking risk. For sensitivity analysis, the role of each assumption is further investigated by removing each factor one at a time.

What Drives Corporate Asset Prices: Short- or Long-Run Risk?

This paper addresses this question with an asset-pricing model featuring endogenous corporate policies. Long-run risk reflects a firm’s profit exposure to slowly-moving expected consumption growth, whereas short-run risk captures the exposure to frequent unexpected changes in consumption growth. Long-run risk reduces a firm’s optimal leverage while driving most of the equity risk premium. The contribution of short-run risk increases during expansions and for firms with higher idiosyncratic volatility, but remains similar across levels of default risk and systematic volatility. These findings contribute to understanding the expected return on a stock, both over time and in the cross-section.

LONG-RUN RISK AND MONEY MARKET RATES: AN EMPIRICAL ASSESSMENT

Using postwar U.S. data, I study the implied interest rates in a simple long-run risk (LRR) model. Empirical estimates show that, as in standard consumption-based models with power utility preferences, the movements of the implied risk-free rate are entirely determined by the variations of expected consumption growth. This leads to a negative relationship between LRR Euler equation rates and money market rates. Nevertheless, when the low-frequency movements of consumption growth are accounted for, the long-run component of consumption growth is a key element to partially capture the countercyclical variations of the money market rates.

Consumption Uncertainty and Precautionary Saving

Using survey data from a representative sample of Dutch households, we estimate the strength of the precautionary saving motive by eliciting subjective expectations on future consumption. We find that expected consumption risk is higher for the young and the self-employed, and is correlated positively with income risk. We insert these subjective expectations (rather than consumption realizations, as in the existing literature) in a Euler equation for consumption, and estimate the degree of prudence by associating expected consumption risk with expected consumption growth. Robust OLS and IV estimates both indicate a coefficient of relative prudence of around 2.

Consumption Uncertainty and Precautionary Saving

Using survey data from a representative sample of Dutch households, we estimate the strength of the precautionary saving motive by eliciting subjective expectations on future consumption. We find that expected consumption risk is higher for the young and the self-employed, and is correlated positively with income risk. We insert these subjective expectations (rather than consumption realizations, as in the existing literature) in a Euler equation for consumption, and estimate the degree of prudence by associating expected consumption risk with expected consumption growth. Robust OLS and IV estimates both indicate a coefficient of relative prudence of around 2.