The conditional covariance between aggregate stock returns and aggregate consumption growth varies substantially over time. When stock market wealth is high relative to consumption, both the conditional covariance and correlation are high. This pattern is consistent with the “composition effect, ” where agents ’ consumption growth is more closely tied to stock returns when stock wealth is a larger share of total wealth. This variation can be used to test asset-pricing models in which the price of consumption risk varies. After accounting for variations in this price, the relation between expected excess stock returns and the conditional covariance is negative. AFTER DECADES OF RESEARCH, financial economists have tentatively concluded that there are predictable variations in excess returns to the stock market. The uncertainty in this conclusion is partially driven by our inability to interpret comfortably these variations in a sensible model of asset pricing. In a world of rational investors who care about consumption, variations in expected excess returns should be driven by variations in either the amount of “consumptio
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