Asset Pricing with Countercyclical Household Consumption Risk

We present evidence that shocks to household consumption growth are negatively skewed, persistent, countercyclical, and play a major role in driving asset prices. We construct a parsimonious model where heterogeneous households have recursive preferences and a single state variable drives the conditional cross-sectional moments of household consumption growth. The estimated model fits well the cross-sectional moments of household consumption growth and the unconditional moments of the risk-free rate, equity premium, market price-dividend ratio, and aggregate dividend and consumption growth. Consistent with empirical evidence, the model-implied risk-free rate and price-dividend ratio are pro-cyclical while the market return has countercyclical mean and variance.