Commentary on "Long-Run Risks and Financial Markets"

and his coauthors begin from the observation that it is difficult to distinguish that specification from an alternative one in which the drift in log consumption growth is itself a highly persistent covariance stationary process with low conditional volatility but high unconditional volatility. Thus, the drift itself is almost but not quite a random walk. The high unconditional volatility of the drift confronts the representative consumer with what Bansal and his coauthors call long-run risk because the conditional mean of consumption growth is not constant but wanders. Bansal also posits that cash flows on particular portfolios differ in the extent to which they are subject to long-run risks that are more or less correlated with the long-run risk in aggregate consumption. For example, Bansal and coauthors as well as Hansen, Heaton, and Li (2006) have offered evidence that the cash flows from Fama and French’s high book-to-market portfolios have longrun components that are more highly correlated with long-run components of consumption than are the cash flows from low book-to-market portfolios. Can the need to compensate the representative consumer for that higher long-run correlation with consumption explain why those high bookto-market portfolios have higher returns?