Explaining the Poor Performance of Consumption-Based Asset Pricing Models / John Y. Campbell, John H. Cochrane.

Format:

Book

Author/Creator:

Campbell, John Y.

Contributor:

National Bureau of Economic Research.

Cochrane, John H.

Series:

Working Paper Series (National Bureau of Economic Research) no. w7237.

NBER working paper series no. w7237

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1999.

Summary:

The poor performance of consumption-based asset pricing models relative to traditional portfolio-based asset pricing models is one of the great disappointments of the empirical asset pricing literature. We show that the external habit-formation model economy of Campbell and Cochrane (1999) can explain this puzzle. Though artificial data from that economy conform to a consumption-based model by construction, the CAPM and its extensions are much better approximate models than is the standard power utility specification of the consumption-based model. Conditioning information is the central reason for this result. The model economy has one shock, so when returns are measured at sufficiently high frequency the consumption-based model and the CAPM are equivalent and perfect conditional asset pricing models. However, the model economy also produces time-varying expected returns, 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, and so portfolio-based models are better approximate unconditional asset pricing models.

Notes:

Print version record

July 1999.