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Explaining the Poor Performance of Consumption-based Asset Pricing Models

  • John Y. Campbell

    (Harvard University and NBER,)

  • John H. Cochrane

    (University of Chicago, Federal Reserve Bank of Chicago and NBER)

We show that the external habit-formation model economy of Campbell and Cochrane (1999) can explain why the Capital Asset Pricing Model (CAPM) and its extensions are betterapproximate asset pricing models than is the standard onsumption-based model. The model economy produces time-varying expected eturns, tracked by the dividend-price ratio. Portfolio-based models capture some of this variation in state variables, which a state-independent function of consumption cannot capture. Therefore, though the consumption-based model and CAPM are both perfect "conditional" asset pricing models, the portfolio-based models are better approximate "unconditional" asset pricing models. Copyright The American Finance Association 2000.

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Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 55 (2000)
Issue (Month): 6 (December)
Pages: 2863-2878

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Handle: RePEc:bla:jfinan:v:55:y:2000:i:6:p:2863-2878
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  1. Mankiw, N Gregory & Shapiro, Matthew D, 1986. "Risk and Return: Consumption Beta versus Market Beta," The Review of Economics and Statistics, MIT Press, vol. 68(3), pages 452-59, August.
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  8. Wayne E. Ferson & George M. Constantinides, 1991. "Habit Persistence and Durability in Aggregate Consumption: Empirical Tests," NBER Working Papers 3631, National Bureau of Economic Research, Inc.
  9. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report 208, Federal Reserve Bank of Minneapolis.
  10. Cochrane, John H, 1996. "A Cross-Sectional Test of an Investment-Based Asset Pricing Model," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 572-621, June.
  11. Kandel, Shmuel & Stambaugh, Robert F, 1995. " Portfolio Inefficiency and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 157-84, March.
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  15. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
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  18. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
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