Stock returns and consumption factors in the Australian market: Cross-sectional tests

We test conditional consumption capital asset pricing models (CCAPMs) in the Australian equity market. The conditional variables used are Lettau and Ludvigson’s (2001a , b ) consumption–wealth ratio, Campbell and Cochrane’s (1999) surplus consumption ratio and Santos and Veronesi’s (2006) labour income to consumption ratio. We examine the cross-sectional implications of these variables using the Fama–French 25 size and book-to-market portfolios and Australian industry portfolios. The Fama–MacBeth (1973) cross-sectional regressions on the 25 size/book-to-market portfolios show that the conditional models perform better than the unconditional models. However, these conditional models cannot outperform the Fama–French three-factor model. The conditional CCAPM, with the labour income to consumption ratio as a scaling factor, can match more closely the performance of the Fama–French three-factor model. We also find that consumption growth is non-contemporaneously related to portfolio returns.