Consumption in asset returns

Using information in returns we identify the stochastic process of consumption. We find that aggregate consumption reacts over multiple quarters to innovations spanned by financial markets, and this persistent component accounts for over a quarter of consumption variation. These shocks are cross-sectionally priced, drive most of the time series variation in stocks, and a small, yet significant, share of volatility of bonds. Nevertheless, we find no support for stochastic volatility of consumption driving timevarying risk premia. Finally, an otherwise standard recursive utility model based on our estimated process explains both equity premium and risk-free rate puzzles with low risk aversion.