Asset Pricing with Left-Skewed Long-Run Risk in Durable Consumption

I document that durable consumption growth is highly persistent and predicted by the price-dividend ratio. This provides strong and direct evidence for the existence of a highly persistent expected component. I also document robust evidence that durable consumption growth is left skewed and exhibits time-varying volatility. These properties motivate a model for durable consumption growth as driven by shocks with counter-cyclical volatility. I embed the durable consumption growth dynamics and i.i.d. nondurable consumption growth in nonseparable Epstein-Zin preferences. The resulting model, together with dividend growth as containing a leverage on the expected component of durable consumption growth, can explain a number of asset pricing phenomena, including pro-cyclical price-dividend ratio, large and counter-cyclical equity premium and return volatility, low and smooth risk-free rate, and the predictability of stock returns. The model also generates the volatility feedback effect and an upward sloping term structure of real bond yields.