Consumption

Using information in returns we identify the stochastic process of consumption – the crucial ingredient of most macro-finance models. We find that aggregate consumption reacts over multiple quarters to innovations spanned by financial markets, and this persistent component accounts for 26% of the consumption variation. These innovations drive most of the time series variation of equity returns and are priced in the cross-sections of both bonds and stocks. The data rejects the hypothesis that the stochastic volatility of consumption is proportional to market volatility, and that either of them is priced, posing a novel challenge for consumption-based asset pricing models