Consumption growth as a risk factor? Evidence from Canadian financial markets

A linear factor model is estimated with Toronto Stock Exchange and Canadian bond market data to evaluate the effects on excess returns of two observable risk factors, namely the return on wealth and consumption growth. The econometric model exploits the restrictions of the linear factor model to estimate conditional betas and to evaluate the size of wealth and consumption risk premia. Results show that the market risk premium is very precisely estimated and does not seem to vary much over the period 1961:1-1999:4. The estimated mean market risk premium is positive and contributes to explain an important part of Canadian stock and bond excess returns. The estimated consumption risk premium is much more variable and its size has been reduced substantially during the nineties.