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Consumption-Based Asset Pricing Models

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  • Rajnish Mehra

    ()
    (Department of Economics and Finance, Arizona State University, Tempe, Arizona 85287
    Luxembourg School of Finance, University of Luxembourg, L-1468 Luxembourg, National Bureau of Economic Research, Cambridge, Massachusetts 02138)

Abstract

A major research initiative in finance focuses on the determinants of the cross-sectional and time series properties of asset returns. With that objective in mind, asset pricing models have been developed, starting with the capital asset pricing models of Sharpe (1964), Lintner (1965), and Mossin (1966). Consumption-based asset pricing models use marginal rates of substitution to determine the relative prices of the date, event-contingent, composite consumption good. This model class is characterized by a stochastic discount factor process that puts restrictions on the joint process of asset returns and per capita consumption. This review takes a critical look at this class of models and their inability to rationalize the statistics that have characterized US financial markets over the past century. The intuition behind the discrepancy between model prediction and empirical data is explained. Finally, the research efforts to enhance the model's ability to replicate the empirical data are summarized.

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File URL: http://www.annualreviews.org/doi/abs/10.1146/annurev-financial-102710-144825
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Bibliographic Info

Article provided by Annual Reviews in its journal Annual Review of Financial Economics.

Volume (Year): 4 (2012)
Issue (Month): 1 (October)
Pages: 385-409

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Handle: RePEc:anr:refeco:v:4:y:2012:p:385-409

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Keywords: equity premium puzzle; life cycle; borrowing constraints; retirement;

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Cited by:
  1. Marcella Lucchetta & Michael Donadelli, 2012. "Emerging Stock Premia: Do Industries Matter?," Working Papers 2012_22, Department of Economics, University of Venice "Ca' Foscari".
  2. Alain Cohn & Jan Engelmann & Ernst Fehr & Michel Maréchal, 2013. "Evidence for countercyclical risk aversion: an experiment with financial professionals," UBSCENTER - Working Papers 004, UBS International Center of Economics in Society - Department of Economics - University of Zurich.

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