European equity markets: Who is the truly representative investor?

While most asset pricing models assume the perspective of the representative investor, the globalization of financial markets makes it difficult to know who the investors whose marginal utility determines market prices really are. Since the majority of investment in European financial markets comes from European countries, we study the performance of the consumption-capital asset pricing model (CCAPM) in the equity markets of the three largest European economies: France, Germany and the United Kingdom. For each nation, we price 25 portfolios sorted by size and book-to-market equity, 30 industry portfolios and 25 portfolios sorted by ROE and asset growth, using both domestic and foreign consumption growth as factors. In order to account for the variability of the parameters over time, we employ a scaled factor model, with the domestic consumer confidence index (CCI) and the consumption-wealth ratio (cay) as instruments. We show that the multi-CCAPM scaled by the CCI performs significantly better than the classic CCAPM, providing results comparable to those of the Fama-French five-factor model.