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C-CAPM and the Cross-Section of Sharpe Ratios

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Author Info
Söderlind, Paul () (University of St. Gallen)

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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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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
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Handle: RePEc:hhs:sifrwp:0018

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

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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  1. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, vol. 83(3), pages 487-512, June. [Downloadable!] (restricted)
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  2. 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. [Downloadable!]
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  3. John Y. Campbell, 2002. "Consumption-Based Asset Pricing," Harvard Institute of Economic Research Working Papers 1974, Harvard - Institute of Economic Research. [Downloadable!]
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  4. 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. [Downloadable!] (restricted)
  5. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March. [Downloadable!] (restricted)
  6. Svensson, Lars E. O., 1989. "Portfolio choice with non-expected utility in continuous time," Economics Letters, Elsevier, vol. 30(4), pages 313-317, October. [Downloadable!] (restricted)
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  7. 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. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
  9. Robert F. Engle & Kevin Sheppard, 2001. "Theoretical and Empirical Properties of Dynamic Conditional Correlation Multivariate GARCH," University of California at San Diego, Economics Working Paper Series 2001-15, Department of Economics, UC San Diego. [Downloadable!]
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  10. 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.
  11. 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. [Downloadable!] (restricted)
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