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C-CAPM and the Cross-Section of Sharpe Ratios

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  • Söderlind, Paul

    ()
    (University of St. Gallen)

Abstract

This paper studies if the consumption-based asset pricing model can explain the cross-section of Sharpe ratios. The CRRA model and several extensions (habit persistence, recursive utility and idiosyncratic shocks) all imply that the Sharpe ratio is linearly increasing in the asset's correlation with aggregate consumption growth. Results from quarterly data on 40 US portfolios (1947-2001) and 10 international portfolios (1957/1971-2001) suggest that both the unconditional and conditional C-CAPM have serious problems: there is a great deal of variation in Sharpe ratios, but most portfolios have relatively similar and low correlations with aggregate consumption growth.

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Bibliographic Info

Paper provided by Institute for Financial Research in its series SIFR Research Report Series with number 18.

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Length: 17 pages
Date of creation: 15 Aug 2003
Date of revision:
Handle: RePEc:hhs:sifrwp:0018

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Keywords: Cosumption-based asset pricing; habit persistence; recursive utility; idiosyncratic risk; multivariate GARCH;

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  1. John Y. Campbell, 2002. "Consumption-Based Asset Pricing," Harvard Institute of Economic Research Working Papers 1974, Harvard - Institute of Economic Research.
  2. Mankiw, N. Gregory, 1986. "The equity premium and the concentration of aggregate shocks," Journal of Financial Economics, Elsevier, vol. 17(1), pages 211-219, September.
  3. Martin Lettau & Sydney Ludvigson, 1999. "Resurrecting the (C)CAPM: a cross-sectional test when risk premia are time-varying," Staff Reports 93, Federal Reserve Bank of New York.
  4. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  5. Ravi Bansal & Robert F. Dittmar & Christian T. Lundblad, 2005. "Consumption, Dividends, and the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 60(4), pages 1639-1672, 08.
  6. Lettau, Martin, 1998. "Idiosyncratic Risk and Volatility Bounds, or, Can Models with Idiosyncratic Risk Solve the Equity Premium Puzzle?," CEPR Discussion Papers 1795, C.E.P.R. Discussion Papers.
  7. John Y. Campbell, 1992. "Intertemporal Asset Pricing Without Consumption Data," NBER Working Papers 3989, National Bureau of Economic Research, Inc.
  8. Svensson, Lars E. O., 1989. "Portfolio choice with non-expected utility in continuous time," Economics Letters, Elsevier, vol. 30(4), pages 313-317, October.
  9. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  10. Robert F. Engle & Kevin Sheppard, 2001. "Theoretical and Empirical properties of Dynamic Conditional Correlation Multivariate GARCH," NBER Working Papers 8554, National Bureau of Economic Research, Inc.
  11. Breeden, Douglas T & Gibbons, Michael R & Litzenberger, Robert H, 1989. " Empirical Tests of the Consumption-Oriented CAPM," Journal of Finance, American Finance Association, vol. 44(2), pages 231-62, June.
  12. Engle, Robert, 2002. "Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 339-50, July.
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