Consumption Capital Asset Pricing Model Research Articles

Bank credit, consumption risk, and the cross-section of expected returns

Although the consumption capital asset pricing model has an unmatched theoretical purity for assets’ risk, the empirical failure of the model stands as a central finding in asset pricing. In an effort to resuscitate consumption-based asset pricing model, we develop and estimate new conditional consumption capital asset pricing models with bank credit growth and bank credit cycle as conditioning variables. Rather than assuming the constant factor loadings of asset returns on consumption growth, we model time-varying consumption beta as a function of bank credit growth or bank credit cycle. We find that our specifications explain satisfactorily the variation in stock returns across the 25 Fama–French portfolios. Moreover, the strict statistical tests on risk price and explanatory power show that the models compare favorably with other renowned asset pricing models. These findings document that the dispersion of expected returns is the outcome of the degree of reward for consumption risk, thereby being consistent with asset pricing theory.

Constant relative risk aversion utility and consumption CAPM: discount factors and risk aversions for Norway, Sweden, and the UK

Constant relative risk aversion utility and consumption CAPM: discount factors and risk aversions for Norway, Sweden, and the UK

The Limitaitons and Alternatives of CAPM

The Capital Asset Pricing Model (CAPM), a conventional financial model, has undergone extensive testing. This research critically examines the limitations of CAPM from four distinct perspectives and offers alternative frameworks. Specifically, this paper delves into these issues through the lens of the Conditional CAPM. Traditionally, CAPM has been viewed as a simplistic single-factor model. The limitations addressed here encompass temporal constraints, uniform expectations, the role of consumption factors, and underlying assumptions of rationality. This study employs a systematic literature review methodology to conduct its analysis. Through carefully selecting samples, our investigation reveals a correlation between the number of papers published and the years in question. Furthermore, certain keywords surface more frequently, indicating emerging phenomena and trends. However, our primary focus remains aligned with the research inquiry, leading us to select 12 samples for in-depth exploration. Ultimately, this paper argues that the Intertemporal CAPM (ICAPM) may ameliorate the time-related constraints inherent in traditional CAPM. Additionally, the Liquidity CAPM (LCAPM) factors in liquidity considerations, offering improvements to CAPM. The Consumption CAPM (CCAPM) augments CAPM's comprehensiveness by introducing consumption factors. Furthermore, the alpha-neutral CAPM and the sentiment-scaled model both acknowledge the influence of investor behaviour on asset pricing.

Investing in a leveraged world

PurposeThroughout the 21st century, US households have experienced unprecedented levels of leverage. This dynamic has been exacerbated by income shortfalls during the COVID-19 crisis. Leveraging and deleveraging decisions affect household consumption. This study investigates the effect of the dynamics of household leverage and consumption on the stock market.Design/methodology/approachThe authors explore the relation between household leverage and consumption in the context of the consumption capital asset pricing model (CCAPM). The authors test the model's implication that leverage has a negative risk premium by transforming the asset pricing restriction into an unconditional linear factor model and estimate the model using the general method of moments procedure. The authors run time-series regressions to estimate individual stocks' exposures to leverage, and cross-sectional regressions to investigate the leverage risk premium.FindingsThe authors show that shocks to household debt have strong and lasting effects on consumption growth. The authors extend the CCAPM to accommodate this effect and find, using various test assets, a negative risk premium associated with household deleveraging. Looking at individual stocks the authors show that the deleveraging risk premium is not explained by well-known risk factors.Originality/valueThis paper contributes to the literature on the role of leverage in economics and finance by establishing a relation between household leverage and spending decisions. The authors provide novel evidence that households' leveraging and deleveraging decisions can be a fundamental and influential force in determining asset prices. Further, this paper argues that household leverage might explain the small, persistent, and predictable component in consumption growth hypothesised in the long-run risk asset pricing literature.

Risky Gravity

Abstract We consider the canonical trade model with heterogeneous firms, love for variety and trade costs, and integrate it in the consumption CAPM model. This yields a structural gravity equation that includes an additional factor related to risk premia. Empirical evidence based on firm-level data confirms the importance of cross-sectional heterogeneity in risk and time-varying risk premia to shape bilateral trade flows. The structural gravity model augmented to account for fluctuations in risk premia offers a compelling explanation for trade collapses during abrupt economic downturns.

Output gap and consumption risk on the cross-section of stock returns in Korea

We examine if output gap can be the conditioning information for consumption-based asset pricing model in the Korean stock market. In an effort to empirically explain the cross-sectional variation of stock returns with economic equilibrium model, our conditioning variable, output gap, enables consumption capital asset pricing model (CCAPM) to explain a substantial variation in the cross-section of stock returns in Korea. In addition, the conditional version of CCAPM with output gap as a conditioning variable can explain the cross-section of stock returns about as well as the Fama-French three- and five-factor model when using future consumption growth. Asset's riskiness is determined by the correlation with consumption growth conditional on the business cycle measured by the output gap. (JEL G12).

Financial Contagion in Network Economies and Asset Prices

This paper studies intertemporal asset pricing in network economies when distress shocks can propagate through the network, similarly to epidemic outbreaks. Two classes of equilibria exist. In the first, idiosyncratic shocks are diversifiable and do not affect valuations; the consumption capital asset pricing model applies. In the second, idiosyncratic shocks generate nondiversifiable long-run cascades of shocks (financial pandemics) that introduce a new risk premium component unexplained by traditional systematic factors. We derive closed solutions for asset prices as a function of the network properties and discuss their properties. After a structural break (1984), we find evidence of a network risk premium that is statistically and economically significant. This paper was accepted by Agostino Capponi, finance. Funding: This work was supported by Ministero dell’Istruzione, dell’Università e della Ricerca [Grant PRIN-2017TA7TYC] and Baffi CAREFIN. C. Tebaldi is a fellow of Baffi CAREFIN and Innocenzo Gasaprini Institute for Economic Research Centers. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4687 .

Currency returns and systematic risk

We investigate the relationship between currency excess returns and Gross Domestic Product (GDP) in a Consumption Capital Asset Pricing Model. GDPs are observable systematic risk factors in our asset pricing equations. The correlation between the unobservable systematic factors is explored by Seemingly Unrelated Regressions estimations. The sample comprises the period from 1999:M01 to 2019:M12 and 48 countries. Results show that GDP growth risk is significant for most currency pairs and portfolios. We also find that they are priced in the cross-section of excess returns. Furthermore, currency returns are directly affected by regional business cycles (Europe, America, and Asia).

How does (C)CAPM digest anomalies?

ABSTRACT In a pioneering effort, we re-evaluate the performance of (C)CAPM (joint CAPM and consumption CAPM) in digesting a large number of anomalies. Our key contribution illustrates that the performance of (C)CAPM appears to be quite sensitive to the choice of weighting matrix. OLS cross-sectional regression reveals the poor performance of (C)CAPM. In contrast, the CAPM model actually explains a large portion of anomalies quite well when using an efficient weighting matrix (GLS), indicating that the prior expectation that the CAPM exhibits poor empirical performance should fundamentally be reversed.

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.

Evaluating the Conditional CAPM using Consumption-based State Variables: Evidence from the Korean Stock Market

In this study, we evaluate the empirical performance of conditional asset pricing models using consumption-based measures as state variables. We incorporate three consumption variables known to forecast the equity risk premium as conditioning variables to capture time variations in the risk premium. These three variables are the consumption-aggregate wealth ratio, the surplus consumption ratio, and the labor income to consumption ratio. The asset pricing models evaluated in this study are the CAPM, the CAPM with human capital, the consumption CAPM, and the Fama-French three-factor model. We compare the unconditional and conditional specifications of these four asset pricing models using the two-pass cross-sectional regression methodology, using the size, book-to-market, turnover, and idiosyncratic risk sorted portfolios and sector portfolios as test assets. We demonstrate that the conditional CAPM with human capital performs far better than the unconditional specifications and about as well as the Fama and French three-factor model in explaining the crosssection of average stock returns in Korea.

The Triumvirate Investment Paradigm : Strategic Asset Allocation in Property, Business, and Country Assets

The purpose of this document is to outline the triumvirate investment paradigm as a strategic asset allocation blueprint for portfolio construction by categorizing assets into three distinct groups: Property, Business, and Country. This triumvirate taxonomy fits better within the economic context of the Consumption Capital Asset Pricing Model, where we detail the macroeconomy in terms of its constituents of Consumption, Business Investment, and Government Expenditures. This segments into broadly equal market capitalization for these groups as well, with an equal importance for each part of the whole. For asset pricing, this leads to the development of Investment Selection within a particular group based on risk and reward characteristics, and the development of Investment Risk as an integral part of the investment process for Portfolio Construction in determining the diversification benefits across each group, where each group is a distinct correlation cluster. In a zero rate economy, adoption of a triumvirate taxonomy in risk budgeting will lead to a shift of sovereign assets towards more equity-like participation in Infrastructure, which fits under the Country asset class. Equally, it will lead to less investment exposure in Private Equity. For ALM providers, it will involve a shift towards more illiquid assets, such as Property, Infrastructure and Private Credit, by recognition that the long-term liabilities are equally illiquid and well matched.

INFLUENCE OF INVESTMENT DECISIONS AND CONSUMPTION ON ASSET PRICING: CCAPM APPROACH

Purpose of the study: This study examines the influence of investment decisions and consumption on asset pricing from 1980 to 2016.
 Methodology: This study has used a quantitative research design and a secondary source is deployed to collect data from 1980 to 2016. The data was gathered from Saint Louis Fed, whereas Standard and Poor’s 500 (S&P 500 index at a closing price of the first day of the month) was from Yahoo Finance. The software used for the data analysis was R Studio and statistical methods such as descriptive statistics, Generalized Method of Moments (GMM) model Fitting and Consumption Capital Asset Pricing Model (CCAPM) Fitting was performed to examine the influence of investment decisions and consumption on asset pricing.
 Main Findings: The finding of the study shows that Personal Consumption Expenditures: Nondurable Goods (PCE): Nondurable goods, (PCEN) and 1-Year Treasury Constant Maturity Rate (GS1) jointly accounted for about 7.9% of the variance observable in excess return SP500. Furthermore, independently, GS1 (annualized 1-Year Treasury Constant Maturity Rate) was significant while PCE (Personal Consumption Expenditures: Nondurable Goods) and PCEN: Nondurable goods were insignificant.
 The implication of the Study: The current study is useful for investors and especially fund managers across the globe to determine what return they expect on their investment for putting their capital at risk on it.
 Novelty/Originality of this study: Studies have been conducted to analyze the impact of investment decision based on the CAPM model, whereas this study introduces the influence of investment decisions and consumption on asset pricing by deploying the CCAPM approach which is an extension of the capital asset pricing model that uses a consumption beta instead of a market beta to explain expected return premiums over the risk-free rate.

Income inequality and stock market returns

We show that the drop in the equity premium since the 1970s can partially be explained by the shifts in the level and composition of U.S. income inequality. To show it, we use a framework that extends the standard production-based Consumption Capital Asset Pricing Model by allowing for heterogeneity of agents, who differ in their ability to hold financial assets and their labor shares of income. The top income group, capital owners, own the firms and provide labor and the rest of the economy is populated by workers who consume their labor income and income from risk-free government and corporate bonds. Intuitively, an increase in the share of capital in income rises the riskiness of consumption and predicts higher equity premium. A rise in the share of capital owners' non-risky labor income leads to lower excess return. Time-series U.S. equity premium regressions and cross-country excess return comparison significantly and robustly validate predictions of the model. The quantitative experiment of shifting capital and labor income shares of capital owners explains one third of the observed reduction in the U.S. equity premium. The reason is that, during the last five decades, capital owners benefited from higher average growth in their non-risky labor income relative to the capital income.

Revisiting the Expected Utility Theory and the Consumption CAPM

The concept of utility is the core component of many foundational theories in social sciences. It has evolved from a philosophical belief that people seek happiness and satisfaction to a mathematically derived theory in economics and finance. Beginning with a brief review of the developments in the Expected Utility Theory (EUT) and its applicability in equity pricing, this paper includes a critical appraisal of relevant theoretical and empirical studies from the fields of financial economics and behavioural studies, with a particular focus on the the Consumption Capital Asset Pricing Model (CCAPM).

Consumer sentiment and time-varying betas: Testing the validity of the consumption CAPM on the Johannesburg Stock Exchange

ABSTRACT We test both the conditional and unconditional versions of the consumption capital asset pricing model (CCAPM) on the Johannesburg Stock Exchange, for the period 1988–2018, and compare its performance with that of the CAPM and the Fama-French three- and five-factor models. We use the consumer confidence index as an instrument to parameterise shifts in betas over time in conditional models. In order to study the robustness of the results at a higher frequency than that of consumption data, we use the mimicking portfolio of the stochastic discount factor tied to the model. Our results show that in all cases the conditional CCAPM performs satisfactorily, outperforming both the CAPM and the Fama-French three-factor model. These results suggest that South African consumption growth and consumer sentiment help explain a large fraction of the expected returns in the Johannesburg Stock Exchange.

Can Bank Credit for Household be a Conditional Variable for Consumption CAPM?

Can Bank Credit for Household be a Conditional Variable for Consumption CAPM?

Composite-asset-risk approach to solving the equity premium puzzle

We demonstrate that the equity premium puzzle can be explained by a combination of modern portfolio theory (MPT) and a consumption capital asset pricing model (CAPM). We assume that an investor maximizes her/his utility as determined by the expected return and risk for a composite asset portfolio including purchasing an equity and selling a riskless asset jointly. If the variance of the composite asset is greater than that expected by the CAPM, then the equity premium puzzle can be resolved according to the MPT. The intrinsic bubbles may explain the observed excessive expectation and variance of equity return premium.

The housing consumption capital asset pricing model with an antichresis rent market: Nonseparability and composition risk

AbstractWe develop a housing consumption capital asset pricing model for economies with an antichresis rent market wherein property owners receive up‐front lump‐sum deposits from renters instead of monthly rents and use it as leverage to acquire housing assets for rent. We estimate the model using antichresis rent market and stock market data for Korea. We find that housing consumption and nonhousing consumption, which are complementary over the long term, have sufficient cross‐sectional elasticity of substitution, leading to a meaningful composition risk premium. We find that the housing expenditure share is procyclical, while intratemporal elasticity of substitution between housing and nonhousing consumption is close to but larger than one and greater than intertemporal elasticity of substitution. As a result, the composition risk arising from the nonseparability of housing and nonhousing consumption induces a sizable positive risk premium. Finally, we examine the effect of interest rate risk by decomposing composition risk into interest rate risk and noninterest rate risk and find that interest rate risk is primarily responsible for the positive composition risk premium.

An Empirical Study of the Sentiment Capital Asset Pricing Model

Market sentiment drives fluctuations in financial markets, but it is measured with empirical proxies lacking strong theoretical foundations. In a generalization of the Consumption CAPM where the representative agent has a prospect theory probability weighting function, we derive a formula for market sentiment that is approximately a decreasing linear function of the conditional market Sharpe ratio, a sufficient statistic for market performance. Our derived sentiment index is negatively correlated with the realized Sharpe ratio, and positively correlated with empirical sentiment indexes. The components of the conditional Sharpe ratio are sufficient to isolate the systematic components of empirical sentiment indexes.