Consumption-based Asset Pricing Research Articles

Real Economy Effects on Consumption-Based CAPM

The consumption-based capital asset pricing model (CCAPM) is an attractive research field in finance, and extant studies have examined the impacts of different factors towards traditional CCAPM, intending to improve the model from the practical perspective. In this paper, we comprehensively scrutinize the real economy effects on the CCAPM by comprising expenditure on durable, expenditure on non-durable goods, services, and real estate four factors. Our study pays great attention to the real economy effect on the CCAPM based on two types of portfolios. By employing both time-series and cross-sectional analysis, our empirical results suggest that the real economy factors can help traditional CCAPM to produce better asset pricing results. Particularly, incorporating the real estate component into the CCAPM model can improve its explanation power on the stock market risk. Our results are potentially useful for investors, portfolios managers and policy makers towards the CCAPM.

Pairs trading and asset pricing

Existing work on pairs trading do not detail how the variables selected explain the cross section of stock returns. We evaluate whether these variables contribute to the dynamics of the equity risk premium for a broadly diversified portfolio of Chinese stocks. Based on pairs trading strategy, several arbitrage-related factors are proposed. In an equilibrium exchange economy, where the idiosyncratic component of the stock return is modeled as per the Ornstein-Uhlenbeck process, the equity risk premium is obtained from a consumption-based asset pricing model. Sorting individual stocks into portfolios based on a single factor, a long-short strategy is formed by buying and selling stocks in the highest and lowest quintiles, respectively. The differences in the subsequent extreme portfolio return are economically large and highly statistically significant. These differences remain significant after controlling for other documented firm characteristics and explanatory variables in the Fama-Macbeth regressions and double sorting.

Peso problems in the estimation of the C‐CAPM

This paper shows that the consumption‐based capital asset pricing model (C‐CAPM) with low‐probability disaster risk rationalizes pricing errors. We find that implausible estimates of risk aversion and time preference are not puzzling if market participants expect a future catastrophic change in fundamentals, which just happens not to occur in the sample (a “peso problem”). A bias in structural parameter estimates emerges as a result of pricing errors in quiet times. While the bias essentially removes the pricing error in the simple models when risk‐free rates are constant, time‐variation may also generate large and persistent estimated pricing errors in simulated data. We also show analytically how the problem of biased estimates can be avoided in empirical research by resolving the misspecification in moment conditions.

Price and Payoff Autocorrelations in a Multi-period Consumption-Based Asset Pricing Model

This paper considers common consumption-based asset pricing model and derives approximations of the basic pricing equation that describes mutual dependence of the mean price "to-day", mean payoff "next-day", price and payoff volatility and impact of the price and payoff autocorrelations. The deep conjunction of the consumption-based model with other modifications of asset pricing as ICAPM, APM and etc. (Cochrane, 2001) causes that our results can be derived in other versions of CAPM. We introduce the market-based price averaging and discuss the origin of its distinctions from the common frequency-based price probability. The market-based price statistical moments, price volatility and autocorrelation are determined by statistical moments of the random market trade value and volume. Distinctions between the frequency-based and the market-based approaches to price averaging cause different assessment of the price volatility and autocorrelation and result in different treatment of the price-volume relations in particular. The market-based price averaging provides direct dependence of the price statistical moments on the market trade value and volume statistical moments. It establishes a unified ground for description of financial markets but uncovers tough complexity. The usage of the frequency-based or proposed market-based price averaging is completely determined by agent's preferences, beliefs and habits. The collision between 'rational' market-based approach and "soulful" or "home-felt" frequency-based approach to price averaging creates significant challenge for financial theory.

Um Tutorial sobre o Método Generalizado dos Momentos (GMM) em Finanças

ABSTRACT Context: empirical problems in which the researcher is faced with a model that is partially specified. In these cases, the GMM method is the natural alternative for estimating the parameters of interest. Objective: the goal of this paper is to offer a tutorial that allows the researcher to understand both the theory and empirical aspects of the GMM method. Methods: we discuss the GMM concepts, forms of estimation, and limitations associated with the method. As a way of illustrating the method, we use two applications in the area of empirical finance. The first application is the estimation of the parameters of a consumption-based asset pricing models; the second is the estimation of the parameters of the evolution of the interest rate in continuous time. The data and codes in R are provided as online appendices. Conclusion: the GMM method can be used in problems where other methods such as maximum likelihood are not feasible, or even when the researcher wants to estimate a model partially specified.

Testing the consumption-based CAPM using the stochastic discount factor

Testing the consumption-based CAPM using the stochastic discount factor

An Empirical Research of the Consumption-based Capital Asset Pricing Model: Evidence from China’s Stock Market

Recently, the Capital Asset Pricing Model has been widely used in the stock market. The traditional Capital Asset Pricing Model has been revised and expanded to the Consumption-based Capital Asset Model. This article does the research in the following ways. Firstly, this article summarizes the Capital Asset Pricing Model and empirical method. Secondly, it analyzes and processes the data worked out of the Capital Asset Pricing Model. Finally, it analyzes the empirical results.

Trade integration and research and development investment as a proxy for idiosyncratic risk in the cross-section of stock returns

Although consumption-based asset pricing constitutes a solid body of work for the purpose of relating asset prices and macroeconomics, most empirical tests put into question the representative investor perspective. Furthermore, most approaches accounting for untraded risks, such as the Constantinides-Duffie model, face the problem of correctly quantifying idiosyncratic risk. In this paper we exploit the strong relationship of income inequality with trade openness and research and development (R&D) investment to proxy the cross-sectional variance of consumption growth by the growth rate of imports plus exports (trade openness) and the growth of the domestic expenditure in R&D. Moreover, we use these variables as a part of the information set used by investors to determine the unconditional version of the conditional consumption-capital asset pricing model (CCAPM). Our results show that both trade openness and R&D investment allow the linearized version of the Constantinides-Duffie model and the conditional CCAPM to greatly outperform the classic CCAPM for different sorts of stock portfolios, contributing significantly to reducing pricing errors. Hence, our results constitute a step forward in the attempt to relate asset prices and income inequality in a tractable way.

The influence of the SARS pandemic on asset prices

The SARS pandemic slowed down household income growth and negatively impacted the financial market. This paper extends the asset pricing literature by providing a new channel to explain the impact of the pandemic on asset prices. First, we propose an income-featuring consumption-based capital asset pricing model (IF-CAPM). Second, the empirical tests show that the IF-CAPM successfully captures structural changes brought about by the SARS pandemic on the financial market and the model performs better than the traditional CAPM.

(C)CAPM vs CAPM: ¿Qué modelo refleja mejor el comportamiento de las acciones en mercados emergentes?

The CAPM is one of the main models in asset pricing due to its simplicity of calculation and popularity into academics and practitioners. However, the empirical evidence has shown its weakness in explaining the stylized facts -behaviors observed in the data- of cross section of the performance of stocks. One of the current theoretical proposals that overcomes the weaknesses of the CAPM is the (C) CAPM, which is a merger of the CAPM and the approach Consumption-based Asset Pricing Model. Since it takes the best of both models, the (C) CAPM has shown better performance for the US data. However, the question remains whether this performance is just as good or better in emerging markets. In this research we answer this question using data for the MILA (Integrated Latin American Market). Likewise, we evaluated the model at an aggregate level (Peru, Mexico, Colombia, and Chile) and sectorial level. The results of this research are complementary to what exists in the literature and would provide a better understanding of the behavior of the performance of the stocks to the academic environment and to the regulatory authorities.

Consumption-Based Asset Pricing When Consumers Make Mistakes

<ns3:p>I analyze the implications of allowing consumers to make mistakes on the risk-return relationships predicted by consumption-based asset pricing models. I allow for consumption mistakes using a model in which a portfolio manager selects investments on a consumer's behalf. The consumer has an arbitrary consumption policy that could reflect a wide range of mistakes. For power utility, expected returns do not generally depend on exposure to single-period consumption shocks, but robustly depend on exposure to both long-run consumption and expected return shocks. I empirically show that separately accounting for both types of shocks helps explain the equity premium and cross section of stock returns.</ns3:p>

S-Shaped Consumption Utility: Empirical Evidence and Implications

Using a macro quantile factor model, we examine cross-state (i.e., cross-quantile) heterogeneity in consumption behaviors. We find that common macro factors generate a “big bang/crunch” effect on micro consumption. Generally speaking, when the aggregate effect of the common factors on the consumption in low consumption-growth states is negative (resp. positive), this effect in high consumption-growth states is positive (resp. negative). The big bang/crunch suggests that consumption utility functions are not concave-shaped but S-shaped. We justify the S shape using consumption-based asset pricing. We show that various consumption-based asset pricing puzzles arise from the global concavity of the utility functions, and the S-shaped consumption utility offers a solution. Also, the S-shaped utility helps explain the low elasticity of intertemporal substitution reported in the literature. In addition, we propose a simple estimation method that allows one to estimate the macro quantile factor model with big data.

Asset Pricing Based on Micro Consumption

This paper shows that consumption-based asset pricing puzzles arise from using globally concave-shaped consumption utility. We empirically find that asset returns correlate negatively with many individuals’ low-quantile consumption growth. This finding challenges most mainstream models and supports an asset pricing model based on S-shaped consumption utility. This new model explains both the low covariance between consumption growth and stock returns and a high equity premium. Moreover, this model shows that applying globally concave-shaped consumption utility mistakenly leads to a positive correlation between risky returns and stochastic discount factors of many individuals, a root for many pricing anomalies.

Adjusting the consumption-based capital asset pricing model by the estimate bid-ask spreads based on daily highest and lowest prices in Iran

Adjusting the consumption-based capital asset pricing model by the estimate bid-ask spreads based on daily highest and lowest prices in Iran

Adjusting the consumption-based capital asset pricing model by the estimate bid-ask spreads based on daily highest and lowest prices in Iran

Adjusting the consumption-based capital asset pricing model by the estimate bid-ask spreads based on daily highest and lowest prices in Iran

Three Remarks On Asset Pricing

The consideration of an averaging interval Δ of market trade time-series change the basic consumption-based asset pricing equation. The duration of Δ determines Taylor series of investor’s utility over current and future values of consumption. We present consumption at current and future moments as sums of their mean values and perturbations during Δ of the price at current moment t and perturbations of the payoff at day t+1. Linear and quadratic Taylor series approximations of the basic equation describe new relations on mean price, mean payoff, their volatilities, skewness and amount of asset ξmax that delivers max to investor’s utility. The stochasticity of market trade time-series defines the randomness of the asset price. We introduce the new price probability measure entirely determined by the probability measures of market trade value and volume. The conventional frequency-based price probability is a special case of the new price probability measure when all trade volumes during the averaging interval Δ equal unit. Prediction of the price probability measure at horizon T equals forecasts of the market trade value and volume probabilities at same horizon.

The term structure of sharpe ratios and arbitrage-free asset pricing in continuous time

<p style="text-indent:20px;">Motivated by financial and empirical arguments and in order to introduce a more flexible methodology of pricing, we provide a new approach to asset pricing based on Backward Volterra equations. The approach relies on an arbitrage-free and incomplete market setting in continuous time by choosing non-unique pricing measures depending either on the time of evaluation or on the maturity of payoffs. We show that in the latter case the dynamics can be captured by a <em>time-delayed</em> backward stochastic Volterra integral equation here introduced which, to the best of our knowledge, has not yet been studied. We then prove an existence and uniqueness result for time-delayed backward stochastic Volterra integral equations. Finally, we present a Lucas-type consumption-based asset pricing model that justifies the emergence of stochastic discount factors matching the term structure of Sharpe ratios.

The Sensitivity of Risk Premiums to the Elasticity of Inter-Temporal Substitution

I incorporate the recursive utility into Pagel (2016)'s reference-dependent preference and study their aggregate implications in a consumption-based asset pricing model. In the case of recursive utility, the proposed model reproduces crucial asset pricing moments and time-varying risk premiums with a simple IID process for consumption growth. Second, the proposed model consistently predicts that the agent prefers a late resolution of uncertainty in both time-separable and recursive utility. My additional finding is that intertemporal substitution elasticity is more sensitive to asset prices given the recursive preference. Finally, the introduction of sluggish-updating can improve model performances.

Can the seasonal pattern of consumption growth reproduce habits in the cross-section of stock returns? Evidence from the European equity market

This paper examines the prevalence for Europe of some well-documented seasonal patterns in consumption data, which allow classic consumption-based asset pricing models to omit an explicit habit specification. We use the Campbell-Cochrane habit model as a reference, proxying habit persistence by the serial correlation of consumer sentiment. Our results show that consumption data for the third and fourth quarters allow the classic power utility function to perform very similarly to the Campbell-Cochrane model, while the serial correlation of consumer sentiment helps improve the explanatory power of habits.

From Which Consumption-Based Asset Pricing Models Can Investors Profit? Evidence from Model-Based Priors

Abstract This article analyzes whether consumption-based asset pricing models improve the excess returns forecasts of a hypothetical investor with access to these models from 1947 onwards. The investor imposes economic constraints derived from asset pricing models as model-based priors on predictive regression parameters through a Bayesian framework. Three models are considered: habit formation, long-run risk, and prospect theory. The model-based priors generally perform better than priors that shrink the parameter estimates to the historical average model and priors that impose a positive equity premium. This analysis helps to assess the value of consumption-based asset pricing models to investors.