The Time Series of the Cross Section of Asset Prices∗

Within a general equilibrium model with habit persistence preferences and time varying expected dividend growth, we obtain a number of novel predictions about the time series of the cross section of asset prices. We show that assets of longer duration, i.e. that pay far in the future, are typically riskier than those of shorter duration. However, those assets that are characterized by a substantial cash flow risk— that is, whose payoffs have high covariance with consumption growth — are riskier when they have shorter duration. In addition, we show that the time variation in the aggregate discount tends to generate a negative correlation between the cross sectional dispersion of price dividend ratios — which is procyclical — and the dispersion of market betas — which is countercyclical. In contrast, the time variation in dividend growth and/or a substantial cash flow risk tend to make the dispersion of return risk also procyclical. Empirically, we find that both the cross sectional dispersion of price dividend ratios and of market betas are indeed procyclical, showing that cash flow effects impact the conditional behavior of asset prices and returns. ∗Very preliminary and incomplete. Please do not circulate or cite without permission. We thank seminar participants at University of Texas at Austin, NYU, University of Illinois at Urbana-Champaign, McGill, MIT, and the University of Chicago. We also thank John Cochrane, George Constantinides, Lars Hansen, John Heaton, Martin Lettau, Toby Moskowitz, and Jessica Wachter for their comments.