NBER Working Paper No. W13896
HANNO N. LUSTIG, University of California, Los Angeles - Department of Economics, National Bureau of Economic Research (NBER) Email: hlustig at econ.ucla.edu STIJN VANNIEUWERBURGH, New York University, National Bureau of Economic Research (NBER) Email: svnieuwe at stern.nyu.edu ADRIEN VERDELHAN, Boston University - Department of Economics, Banque de France - Economic Study and Research Division Email: av at bu.edu
We propose a new method to measure the wealth-consumption ratio. We estimate an exponentially affine model of the stochastic discount factor on bond yields and stock returns and use that discount factor to compute the no-arbitrage price of a claim to aggregate US consumption. We find that total wealth is much safer than stock market wealth. The consumption risk premium is only 2.2%, substantially below the equity risk premium of 6.9%. As a result, our estimate of the wealth-consumption ratio is much higher than the price-dividend ratio on stocks throughout the post-war period. The high wealth-consumption ratio implies that the average US household has a lot of wealth, most of it human wealth. The wealth-consumption ratio also has lower volatility than the price-dividend ratio on equity. A variance decomposition of the wealth-consumption ratio shows that future returns account for most of its variation. The predictability is mostly for future interest rates, not future excess returns. We conclude that the properties of total wealth are more similar to those of a long-maturity bond portfolio than those of a stock portfolio. Many dynamic asset pricing models require total wealth returns as inputs, but equity returns are commonly used as a proxy. The differences we find between the risk-return characteristics of equity and total wealth suggest that equity is special.