Bonds, Aggregate Wealth, and Stock Market Risk

Abstract

Bond returns predict consumption growth after controlling for equity returns, which suggests that bonds capture important information about aggregate wealth. Consistent with this, bond risk is priced in the cross section of stocks. Bond risk partially explains momentum profitts and the flat cross-sectional relation between stock index beta and returns. The results suggest that stock indices are an insufficient proxy for aggregate wealth and that bond risk is an important component of consumption risk. Also, term structure-based return predictability often declines with risk, suggesting that time-variation in risk premia is not the sole driver of such predictability.

Keywords: Stock Market, Corporate Bonds, Consumption, Aggregate Wealth, Cross Section

JEL Classification: G12