Claudio Tebaldi (Universita’ Bocconi)

“Long Run Risk and the Persistence of Consumption Shocks”

abstract

In a long run risk valuation model, agents observe directly the structural drivers of consumption growth and produce a selective response to these shocks. Persistence heterogeneity complicates the empirical analysis of consumption growth dynamics and the detection of long run risk: the econometrician observes only aggregate quantities and is unable to disentangle shocks with different economic origin and persistence.

To alleviate this problem in this paper we introduce a decomposition of aggregate consumption growth in cyclical components classified by their level of persistence. Empirical estimation proves that some of these components are predictable, highly correlated with well known economic proxies of consumption variability. A new test, robust to persistence heterogeneity, produces an estimate of the IES strictly greater than one and robust across subsamples. A valuation model properly modified to account for the dieffrent layers of persistence in consumption growth generates a term-structure of sizeable long run risk premia.