Idiosyncratic risk and the equity premium: Evidence from the consumer expenditure survey

This paper investigates whether uninsured idiosyncratic risk accounts for the equity premium. Following Mankiw (J. Financial Econ. 17 (1986) 211), the paper develops an equilibrium factor model in which risk premia depend on the covariance between an asset's return and certain moments of the cross-sectional distribution for consumption growth. Cross-sectional consumption factors are constructed using data from the Consumer Expenditure Survey, but they do not appear to be promising candidates for explaining the equity premium. The cross-sectional factors are weakly correlated with stock returns and generate equity premia of 2 percent or less for preference specifications with low degrees of risk aversion.