What Determines China’s Stock Prices? A CCAPM Horse Race

Abstract

This paper studies China’s stock prices in the framework of consumption-based capital asset pricing models (CCAPM). Using China’s quarterly stock market data from 1991 to 2019, we estimate and compare four versions of CCAPM: the classical CCAPM, CCAPM with housing service consumption, with habit formation, and with both. We find habit formation affects stock returns only if housing service consumption is considered. Further, although every model is consistent with data to certain extent, the models with habit formation perform substantially better. In particular, the model with both habit formation and housing service consumption fits the data best and has the largest explanatory power on risk premium. The findings imply that habit formation is an important determinant of China’s stock prices, and its impact is mostly via the channel of housing service consumption.