Aggregate Consumption and the Predictability of Asset Returns.

This article analyzes the predictability of asset returns that are discounted using a consumption-based discount factor. The main objective of the analysis is to investigate how ancillary statistical assumptions affect the performance of this model. It is shown that, unlike tests of constant-discount-rate models, tests of consumption-based models do not critically depend on statistical assumptions; for sufficiently high discount rates, there exist intuitively plausible rates of risk aversion for which appropriately discounted returns are unpredictable, regardless of the statistical specification. Test results are determined by serial correlation properties of prices and dividends and not by serial-correlation properties of returns.