Explaining the Poor Performance of Consumption‐based Asset Pricing Models

John Y. Campbell; John H. Cochrane

doi:10.1111/0022-1082.00310

Journal of Finance Vol. 55 No. 6 2000

Explaining the Poor Performance of Consumption‐based Asset Pricing Models

John Y. Campbell^1,2,3; John H. Cochrane^4,5,6

¹ National Bureau of Economic Research · ² Harvard University Press · ³ Dana-Farber/Harvard Cancer Center · ⁴ U.S. National Science Foundation · ⁵ University of Chicago · ⁶ Federal Reserve Bank of Chicago

open access

Abstract

We show that the external habit‐formation model economy of Campbell and Cochrane (1999) can explain why the Capital Asset Pricing Model (CAPM) and its extensions are betterapproximate asset pricing models than is the standard onsumption‐based model. The model economy produces time‐varying expected eturns, tracked by the dividend–price ratio. Portfolio‐based models capture some of this variation in state variables, which a state‐independent function of consumption cannot capture. Therefore, though the consumption‐based model and CAPM are both perfect conditional asset pricing models, the portfolio‐based models are better approximate unconditional asset pricing models.

DOI: 10.1111/0022-1082.00310
Volume: 55
Issue: 6
Pages: 2863-2878
Language: en
Sources: bibtex:phds-export.bib openalex crossref

Explaining the Poor Performance of Consumption‐based Asset Pricing Models

Abstract

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