Durability of Output and Expected Stock Returns

Abstract

The demand for durable goods is more cyclical than that for nondurable goods and services. Consequently, the cash flows and stock returns of durable-good producers are exposed to higher systematic risk. Using the benchmark input-output accounts of the National Income and Product Accounts, we construct portfolios of durable-good, nondurable-good, and service producers. In the cross section, an investment strategy that is long on the durable-good portfolio and short on the service portfolio earns a risk premium exceeding 4 percent annually. In the time series, an investment strategy that is long on the durable-good portfolio and short on the market portfolio earns a countercyclical risk premium. We explain these findings in a general equilibrium asset-pricing model with endogenous production. Disciplines Finance and Financial ManagementThis journal article is available at ScholarlyCommons: http://repository.upenn.edu/fnce_papers/404 941 [ Journal of Political Economy, 2009, vol. 117, no. Durability of Output and Expected Stock Returns João F. Gomes University of Pennsylvania and London Business School Leonid Kogan Massachusetts Institute of Technology and National Bureau of Economic Research Motohiro Yogo University of Pennsylvania and National Bureau of Economic ResearchThe demand for durable goods is more cyclical than that for nondurable goods and services. Consequently, the cash flows and stock returns of durable-good producers are exposed to higher systematic risk. Using the benchmark input-output accounts of the National Income and Product Accounts, we construct portfolios of durable-good, nondurable-good, and service producers. In the cross section, an investment strategy that is long on the durable-good portfolio and short on the service portfolio earns a risk premium exceeding 4 percent annually. In the time series, an investment strategy that is long on the durable-good portfolio and short on the market portfolio earns a countercyclical risk premium. We explain these findings in a general equilibrium asset-pricing model with endogenous production.For comments and discussions, we thank

Investor Sentiment, Product Features, and Advertising Investment Sensitivities

“…It has also been well documented in the literature that consumer expenditures on durable goods are more cyclical than consumer expenditures on non-durable goods and that income elasticity of demand is larger for non-durable goods (Bagwell, 2007). Gomes et al (2009) further show that the cash flow of durable goods producers is more volatile than the cash flow of non-durable goods producers, especially when the economy is in recession. From this perspective, the durable goods manufacturers will rely more on advertising during recessions to boost their revenue.…”

The Epstein–Zin Model with Liquidity Extension

“…17 Bansal and Yaron (2004) (2005), we measure consumption risk by using the consumption growth of nondurable goods over 36 months (cg36) to test the liquidity-extended Epstein-Zin model. Specifically, we run the following two cross-sectional regressions: Recent studies point out that, when utility is nonseparable in nondurable and durable consumption, the durable goods play an important role in determining expected returns (Yogo, 2006;Gomes, Kogan and Yogo, 2009). Following Yogo (2006), we incorporate the durable consumption growth (cgd) into our model and run the following two cross-sectional regressions:…”

“…In Panel D, we expand the 25 Fama-French portfolios with five value-weighted industry portfolios following Lewellen, Nagel and Shanken (2010). We classify the five industries following Gomes, Kogan and Yogo (2009). We report the estimated risk premium and price of covariance risk using both the ordinary least squares (OLS) and generalized least squares (GLS) regressions.…”

“…In addition, we expand the 25 Fama-French value-weighted size and book-to-market portfolios with five value-weighted industry portfolios following Lewellen, Nagel and Shanken (2010). The classification of the five industries is based on Gomes, Kogan and Yogo (2009 associated with the hypothesis that the squared HJ distances of two competing models are equal. We report the results using both the ordinary least squares (OLS) and generalized least squares (GLS) estimates.…”

“…The null hypothesis that the squared HJ distances are equal is generally rejected based on the tests of Kan and Robotti (2009).Lewellen, Nagel and Shanken (2010) argue that, for pricing tests, it is important to include other sets of portfolios (e.g., industry portfolios) to break down the structure of size and book-to-market portfolios. 5 Recent studies also highlight the importance of the consumption-to-wealth ratio (Lettau and Ludvigson, 2001), long-run consumption risk (Parker and Julliard, 2005; Malloy, Moskowitz and Vissing-Jørgensen, 2009), and durable goods (Yogo, 2006;Gomes, Kogan and Yogo, 2009) in consumptionbased asset pricing. In our robustness tests, we take these issues into account and find that both the liquidity risk premium and the coefficient of the covariance risk between return and liquidity risk factor are significant.…”