I saw a concept called “Bad Consumption Hedge”. Who could use more common words to explain this concept? I’m a bit confused about this concept. It’s from Reading 50 - ERP. It says "Sharp falls in equity prices are associated with recessions-bad times." “It’s difficult to argue that equities are a good hedge for bad consumption outcomes. We would thus expect the ERP to be positive”
Thanks!
the concept is when economic times are bad, equity is not a good asset to have (poor hedgers for recession times) because equity prices is highly dependent and positively correlated with economic cycles (good cycle, good price. bad cycle, bad price)
when economic times are bad, people prefer to save and consume less (high marginal utility of future consumption compared to marginal utility of current consumption) and due to the nature of equity investments, it drives equity prices down.
an asset which increases in price during bad times is the risk-free asset (good cycle, lower price. bad cycle, higher price).
Thanks, Edbert! I have passed the level 2. How about your level 3?