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Explaining the Poor Performance of Consumption-Based Asset Pricing Models

  • Campbell, John
  • Cochrane, John

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.

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File URL: http://dash.harvard.edu/bitstream/handle/1/3163265/campbellnber_poorperformance.pdf
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Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 3163265.

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Date of creation: 2000
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Publication status: Published in Journal of Finance
Handle: RePEc:hrv:faseco:3163265
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Web page: http://www.economics.harvard.edu/

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  1. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing Specification Errors in Stochastic Discount Factor Models," NBER Technical Working Papers 0153, National Bureau of Economic Research, Inc.
  2. Matthew D. Shapiro & N. Gregory Mankiw, 1985. "Risk and Return: Consumption Beta Versus Market Beta," Cowles Foundation Discussion Papers 738, Cowles Foundation for Research in Economics, Yale University.
  3. 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.
  4. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report 208, Federal Reserve Bank of Minneapolis.
  5. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
  6. 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.
  7. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 01-90, Wharton School Rodney L. White Center for Financial Research.
  8. Sanford J. Grossman & Robert J. Shiller, 1980. "The Determinants of the Variability of Stock Market Prices," NBER Working Papers 0564, National Bureau of Economic Research, Inc.
  9. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  10. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  11. Shanken, Jay, 1987. "Multivariate proxies and asset pricing relations : Living with the Roll critique," Journal of Financial Economics, Elsevier, vol. 18(1), pages 91-110, March.
  12. 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.
  13. 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.
  14. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
  15. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  16. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
  17. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
  18. Wheatley, Simon, 1988. "Some tests of international equity integration," Journal of Financial Economics, Elsevier, vol. 21(2), pages 177-212, September.
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