Consumption-based capital asset pricing models: issues and controversies

Abstract

This paper discusses the issues and controversies surrounding consumption-based capital asset pricing models (CCAPMs). While CCAPMs provide a chance to explain the phenomena observed in stock markets, their viability is jeopardized owing to the weak predictability of the equity premium and risk-free rate puzzles. Even given market frictions and market incompleteness, CCAPMs must test their validity constantly in the face of the formidable challenges of rival models. Measurement error with respect to time aggregation is also regarded as a major threat, causing the low volatility of consumption and eventually resulting in chaining itself to weak return predictability. In addition, the dual choice problem of portfolio and consumption rooted in CCAPMs guides us into how investors accumulate wealth through the financial market to reach the zenith of expected utility. This paper offers insights as well as understanding into the behavior of an agent and market phenomena in the context of a consumption-based economy.