Are there multiple common factors in household consumption growth?

Abstract

Classical consumption-based asset pricing models typically imply the existence of only one common factor in household consumption growth |aggregate consumption growth. This study examines whether there are multiple common factors in household consumption growth using a novel dataset and methodology. We find that i) there is a significant cross-sectional variation in household consumption growth, and ii) the cross-sectional variation is partially explained by exposure to multiple common factors orthogonal to aggregate consumption growth. Further, household exposure to the most pervasive common factor after aggregate consumption growth is related to the amount of human capital such as labor income, education and age, and their ability to hedge idiosyncratic shocks using borrowing collateral such as the housing wealth and liquid investments. This suggests that the source of additional common factors in consumption is related to an incomplete market for consumption insurance of households.