Consumption and asset prices

Employing aggregate consumption data to test the consumption‐based capital asset pricing model (CCAPM) is likely to lead to a specification error since a significant portion of consumers live from paycheck‐to‐paycheck and, therefore, are constrained in their ability to intertemporally allocate consumption. Furthermore, these consumers lack the savings needed to directly influence an equilibrium between consumption expenditures and asset returns. Using consumption expenditures grouped by consumer income, this paper examines the issue of whether the CCAPM is more consistent with the consumption of unconstrained (high‐income) consumers as compared to constrained (low‐income) consumers. Several traditional methods of analyzing the CCAPM are explored utilizing five time series of consumption expenditures delineated by consumer income. This approach allows us to indirectly test whether liquidity constraints affect the CCAPM without imposing additional specification on the model. Overall, the tests fail to find any discernible patterns across income groups that are consistent with the idea that liquidity constraints bind lower income consumers.