Date: June 24th, Thurs. 17:15-18:45
Speaker: Mr Kenji Wada (Keio University)
Co-Author: Parantap Basu (Durham University)
Title: Household Risk and UK Financial Markets
(Abstract)
Consumption inequality measured by cross sectional variance and skewness of consumption is counter-cyclical in UK. We explore the implications of this stylized fact for UK Financial markets. We construct a measure of business cycle risk facing the households using the methodology described by Constantinides and Ghosh (2017). Households are subject to infrequent uninsurable shock to their consumption due to business cycle risk. We find that the arrival rate of this consumption shock is positively associated with the observed consumption inequality. Thus household risk is also countercyclical and it rises during the recession. This risk impacts the pricing kernel in an incomplete market economy and through this channel it transmits to the financial market fluctuations. Our model predicts that the risk free rate rises, the price/dividend ratio falls and the market portfolio return rises during the recession. The house-hold risk explains much of the risk free rate and market portfolio return fluctuations when households have moderate risk tolerance. Our model predictions are broadly consistent with a few episodes of UK recession.
Keywords: uninsurable household risk, riskfree rate, market return, consumption inequality SDF
JEL classification: G12, E32, E43
