Trade integration and research and development investment as a proxy for idiosyncratic risk in the cross-section of stock returns

Although consumption-based asset pricing constitutes a solid body of work for the purpose relating prices and macroeconomics, most empirical tests put into question representative investor perspective. Furthermore, approaches accounting untraded risks, such as Constantinides-Duffie model, face problem correctly quantifying idiosyncratic risk. In this paper we exploit strong relationship income inequality with trade openness research development (R&D) investment to proxy cross-sectional variance consumption growth by rate imports plus exports (trade openness) domestic expenditure in R&D. Moreover, use these variables part information set used investors determine unconditional version conditional consumption-capital model (CCAPM). Our results show that both R&D allow linearized CCAPM greatly outperform classic different sorts stock portfolios, contributing significantly reducing errors. Hence, our constitute step forward attempt relate tractable way. • Untraded risks agent approach pricing. Trade are useful proxies These clearly CCAPM. strongly informative when instruments.