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Capital Asset Pricing Model and Stochastic Volatility: A Case study of India

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  • Fung, Ka Wai Terence
  • Demir, Ender
  • Zhou, Lu

Abstract

Bansal and Yaron (2004) demonstrate, by calibration, that the Consumption-Based Capital Asset Pricing Model (CCAPM) can be rescued by assuming that consumption growth rate follows a stochastic volatility model. They show that the conditional equity premium is a linear function of conditional consumption and market return volatilities, which can be estimated handily by various Generalized Autoregressive Conditonal Heterskedasticity (GARCH) and Stochastic Volatility (SV) models. Using the data from India, we find that conditional consumption and market volatilities are capable of explaining cross-sectional return differences. Also, the model prediction is consistent with observed declining equity premium.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 56180.

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Date of creation: 2014
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Handle: RePEc:pra:mprapa:56180

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Keywords: Financial Economics; Macroeconomics and Monetary Economics; Equity Premium Puzzle;

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