Consumption through risk premium shocks

Abstract

We propose different methods to measure the impact of shocks to the common factor of all asset returns and use these shocks to identify a long-run component in consumption growth. By utilizing a valid stochastic discount factor, a link between consumption and asset returns, and integrating it with different identification strategies from the SVAR literature, we are able to model and assess the effects of these shocks on consumption. We document a significant impact of shocks to the stochastic discount factor on aggregate consumption growth.