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Idiosyncratic Consumption Risk and the Cross Section of Asset Returns




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    • Jacobs is from the Faculty of Management, McGill University, and CIRANO; Wang is from the Joseph L. Rotman School of Management, University of Toronto. We would like to thank Joao Cocco, Francisco Gomes, Rick Green, Raymond Kan, Yuming Li, Tom McCurdy, Valery Polkovnichenko, Sergei Sarkissian, Raman Uppal, Petr Zemcik, an anonymous referee and seminar participants at the 2003 AFA meeting, the 2002 EFA meeting, the universities of Tilburg, Leuven, and Gent, Charles University in Prague, and the London Business School for helpful comments. We are also grateful to Eugene Fama and Raymond Kan for providing us with the asset return data. Jacobs acknowledges FCAR and SSHRC, and Wang acknowledges SSHRC and the Connaught Fund at the University of Toronto for financial support.


This paper investigates the importance of idiosyncratic consumption risk for the cross-sectional variation in asset returns. We find that besides the rate of aggregate consumption growth, the cross-sectional variance of consumption growth is also a priced factor. This suggests that consumers are not fully insured against idiosyncratic consumption risk, and that asset returns reflect their attempts to reduce their exposure to this risk. The resulting two-factor consumption-based asset pricing model significantly outperforms the CAPM, and its performance compares favorably with that of the Fama–French three-factor model.

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