The Wealth-Consumption Ratio

Abstract

To measure the wealth-consumption ratio, we estimate an exponentially affine model of the stochastic discount factor on bond yields and stock returns. We use that discount factor to compute the no-arbitrage price of a claim to aggregate US consumption. Our estimates indicate that total wealth is much safer than stock market wealth. The consumption risk premium is only 2.2 percent, substantially below the equity risk premium of 6.9 percent. As a result, our estimate of the wealth-consumption ratio is much higher than the price-dividend ratio on stocks throughout the post-war period. The high wealth-consumption ratio implies that the average US household has a lot of wealth, most of it human wealth. A variance decomposition of the wealth-consumption ratio shows less return predictability than for stocks, and some of the return predictability is for future interest rates not future excess returns. We conclude that the properties of the average US household’s portfolio are more similar to those of a long-maturity bond than those of stocks. The differences that we find between the risk-return characteristics of equity and total wealth suggest that equity is a special asset class.