Durable consumption and asset returns: Cointegration analysis

We incorporate durable consumption and cointegration specifications into a standard consumption asset pricing model, and use a Bayesian stochastic search approach to investigate both the cross-sectional variation in expected asset returns and the time variation in the equity premium at various investment horizons. Using U.S. data, we find that involving durable consumption into the cointegrating equation significantly improves the cross-section explanation of the consumption model. In addition, with the increase of the investment horizon, durable consumption accounts for more time variation of equity premium. Our empirical results indicate that the durable consumption risk should not be ignored in asset pricing.