Hui Guo, Zijun Wang, Jian Yang
Journal of Money, Credit and Banking, Vol. 45, Issue 4, pp. 623-650

We uncover a strong comovement of the stock market risk–return trade-off with the consumption–wealth ratio (CAY). The finding reflects time-varying investment opportunities rather than countercyclical aggregate relative risk aversion. Specifically, the partial risk–return trade-off is positive and constant when we control for CAY as a proxy for investment opportunities. Moreover, conditional market variance scaled by CAY is negatively priced in the cross-section of stock returns. Our results are consistent with a limited stock market participation model, in which shareholders require an illiquidity premium that increases with CAY, in addition to the risk premium that is proportional to conditional market variance.