Long-run Consumption Risk and International Stock Returns : A Century of Evidence

We estimate consumption based asset pricing models using consumption and equity market data for fifteen countries from 1900 to 2008 in a setting where investors have recursive utility. We find strong evidence that a long-run risk consumption CAPM that prices international stock returns via their exposures to multi-period consumption growth in world consumption performs considerably better in explaining the international cross-section of returns than the canonical consumption CAPM. By virtue of the long-run data set, we are also able to relate the importance of world consumption risk for the cross-section of international stock returns to periods of high and low capital market integration. It turns out that the extent to which returns are exposed to world consumption growth indeed di ffers across periods: During the early part of our sample period, when international capital mobility was high, stock returns' exposure to world consumption growth is important. Local consumption growth, however, is more important for the post-WWII period when international capital mobility was generally low except for the last two decades