Demand-Driven Risk and the Cross-Section of Expected Returns

Abstract

Firms that concentrate their activities towards goods with higher income elasticity are more exposed to demand-driven risk since the consumption of high-consumption households is more exposed to aggregate shocks. These firms earn higher risk-adjusted equity returns. A portfolio that goes long on the most exposed firms and short on the least exposed gets an abnormal risk-adjusted annual return of 7.5%. This risk does not seem to be coming from competition. A portfolio that goes long in firms exposed to demand-driven risk and competitive pressure and short on firms not exposed to demand-driven risk nor competitive pressure earns an abnormal risk-adjusted annual return of 14%.