BPEA | 2001 No. 2

The Consumption Risk of the Stock Market

Jonathan A. Parker
Jonathan Parker
Jonathan A. Parker Professor of Finance - MIT Sloan School of Management
discussants: N. Gregory Mankiw and
N. Gregory Mankiw Robert M. Beren Professor of Economics - Harvard University
Paul Willen
Paul Willen headshot
Paul Willen Senior Economist and Policy Advisor - Federal Reserve Bank of Boston

2001, No. 2

OVER THE PAST century in the United States, the average annual return on
the stock market has exceeded that on short-term government bonds by
6 percentage points. The natural economic explanation for the premium on
equity is the greater risks associated with investing in the stock market.
However, the large premium that we observe cannot be explained by the
canonical, consumption-based asset pricing model. Risk is best measured
as the extent to which a return alters marginal utility. Since marginal utility
is closely related to consumption, and consumption moves little with
returns, the measured risk of the stock market is small.