Consumption-based CAPM with belief heterogeneity

Abstract

This paper finds that the risk–return relationship of the consumption-based CAPM is robust to the heterogeneity in agents׳ beliefs. First, the effect of disagreement cancels out in the limit as risk tolerance approaches zero. Second, although low risk aversion and large disagreement can significantly distort the security market line (SML) and the effect is amplified in a dynamic model, per capita volatility of consumption growth is implausibly high compared to empirical estimates from microeconomic data. Third, increasing risk aversion and lowering disagreement levels can help to reduce per capita volatility, however the impact of disagreement on the SML also become negligible.