Using information in returns we identify the stochastic process of consumption. We find that aggregate consumption reacts over multiple quarters to innovations spanned by financial markets. This persistent component accounts for over a quarter of consumption variation. These shocks command a large and significant risk premium, driving a large share of stocks and a small yet significant fraction of bonds time series variation. Nevertheless, we find no support for stochastic volatility of consumption driving time-varying risk premia. Finally, an otherwise standard recursive utility model based on our estimated process explains equity premium and risk-free rate puzzles with low risk aversion.
This is a revised version of November 2025. The previous version was dated January 2020.
