1932

Abstract

This article, Part 1 of 2, reviews the classical origins, development, and tests of consumption-based asset pricing theory, focusing mainly on the first two decades from 1976 to 1998. Starting with the original consumption capital asset pricing model (CCAPM) derivations, we review both theory and subsequent tests and provide some new applications. The consumption aggregation theorem and CCAPM are derived, and optimal consumption and portfolio strategies are discussed. The term structure of interest rates is derived from the term structures for expected growth, volatility, and inflation. Time aggregation biases in consumption betas as well as the usefulness of the “consumption-mimicking portfolio” are also derived. In addition to various empirical tests, models and tests of limited participation in asset markets as well as models of incomplete markets are presented. When certain measurement issues are taken into account, the CCAPM performs better than the original CAPM and nearly as well as the Fama-French three-factor model.

Loading

Article metrics loading...

/content/journals/10.1146/annurev-financial-111914-041800
2015-12-07
2024-06-24
Loading full text...

Full text loading...

/deliver/fulltext/financial/7/1/annurev-financial-111914-041800.html?itemId=/content/journals/10.1146/annurev-financial-111914-041800&mimeType=html&fmt=ahah

Literature Cited

  1. Arrow KJ. 1964. The role of securities in the optimal allocation of risk-bearing. Rev. Econ. Stud. 31:291–96 [Google Scholar]
  2. Attanasio PO, Weber G. 1989. Intertemporal substitution, risk aversion and the Euler equation for consumption. Econ. J. 99:59–73 [Google Scholar]
  3. Backus DK, Smith GW. 1993. Consumption and real exchange rates in dynamic economies with non-traded goods. J. Int. Econ. 35:297–316 [Google Scholar]
  4. Bansal R, Yaron A. 2004. Risks for the long run: a potential resolution of asset pricing puzzles. J. Finance 59:41481–509 [Google Scholar]
  5. Bodie Z, Kane A, Marcus AJ. 2011. Investments New York: McGraw-Hill Irwin, 9th ed.. [Google Scholar]
  6. Bollerslev T, Engle R, Woolridge J. 1988. A capital asset pricing model with time-varying covariances. J. Polit. Econ. 96:116–31 [Google Scholar]
  7. Brandt MW, Cochrane JH, Santa-Clara P. 2006. International risk sharing is better than you think, or exchange rates are too smooth. J. Monet. Econ. 53:671–98 [Google Scholar]
  8. Brav A, Constantinides GM, Geczy CC. 2002. Asset pricing with heterogeneous consumers and limited participation: empirical evidence. J. Polit. Econ. 110:4793–824 [Google Scholar]
  9. Breeden DT. 1977. Changes in consumption and investment opportunities and the valuation of securities PhD Thesis, Stanford Univ. [Google Scholar]
  10. Breeden DT. 1979. An intertemporal asset pricing model with stochastic consumption and investment opportunities. J. Financ. Econ. 7:3265–96 [Google Scholar]
  11. Breeden DT. 1980. Consumption risk in futures markets. J. Finance 35:2503–20 [Google Scholar]
  12. Breeden DT. 1984. Futures markets and commodity options: hedging and optimality in incomplete markets. J. Econ. Theory. 32:2275–300 [Google Scholar]
  13. Breeden DT. 1986. Consumption, production, inflation and interest rates: a synthesis. J. Financ. Econ. 16:13–39 [Google Scholar]
  14. Breeden DT. 1991. Consumption and market risks of corporate cash flows . Working Pap., Fuqua Sch. Bus., Duke Univ. [Google Scholar]
  15. Breeden DT. 2004. Optimal dynamic trading strategies. Econ. Notes 33:155–81 [Google Scholar]
  16. Breeden DT. 2005. Distinguished speaker handout Presented at West. Finance Assoc. Annu. Meet., June, Portland [Google Scholar]
  17. Breeden DT. 2013. Consumption as a leading indicator Work. Pap., Mass. Inst. Technol., Duke Univ. [Google Scholar]
  18. Breeden DT, Gibbons MR, Litzenberger RH. 1989. Empirical tests of the consumption-oriented CAPM. J. Finance 44:2231–62 [Google Scholar]
  19. Breeden DT, Litzenberger RH. 1978. Prices of state-contingent claims implicit in option prices. J. Bus. 51:4621–51 [Google Scholar]
  20. Campbell JY. 1987. Stock returns and the term structure. J. Financ. Econ. 18:373–99 [Google Scholar]
  21. Campbell JY, Cochrane JH. 1999. By force of habit: a consumption-based explanation of aggregate stock market behavior. J. Polit. Econ. 107:2205–51 [Google Scholar]
  22. Campbell JY, Mankiw NG. 1989. Consumption, income and interest rates: reinterpreting the time series evidence NBER Work. Pap. 2924 [Google Scholar]
  23. Chen N, Roll R, Ross SA. 1986. Economic forces and the stock market. J. Bus. 59:3383–403 [Google Scholar]
  24. Constantinides GM. 1990. Habit formation: a resolution of the equity premium puzzle. J. Polit. Econ. 98:519–43 [Google Scholar]
  25. Constantinides GM, Duffie D. 1996. Asset pricing with heterogeneous consumers. J. Polit. Econ.219–40 [Google Scholar]
  26. Cox JC, Huang CF. 1989. Optimal consumption and portfolio policies when asset prices follow a diffusion process. J. Econ. Theory 49:133–83 [Google Scholar]
  27. Cox JC, Ingersoll JE Jr, Ross SA. 1985. A theory of the term structure of interest rates. Econometrica 53:2385–407 [Google Scholar]
  28. Dotsey M. 1998. The predictive content of the interest rate term spread for future economic growth, Federal Reserve Bank of Richmond. Econ. Q. 84:331–51 [Google Scholar]
  29. Duffie D, Huang CF. 1985. Implementing Arrow-Debreu equilibria by continuous trading of few long-lived securities. Econometrica 53:61337–56 [Google Scholar]
  30. Dunn KB, Singleton KJ. 1986. Modeling the term structure of interest rates under non-separable utility and durability of goods. J. Financ. Econ. 17:127–55 [Google Scholar]
  31. Dusak K. 1973. Futures trading and investor returns: an investigation of commodity market risk premiums. J. Polit. Econ. 81:61387–1406 [Google Scholar]
  32. Estrella A, Hardouvelis GA. 1991. The term structure as a predictor of real economic activity. J. Finance 46:2555–76 [Google Scholar]
  33. Fama EF. 1970a. Efficient capital markets: a review of theory and empirical work. J. Finance 25:2383–417 [Google Scholar]
  34. Fama EF. 1970b. Multiperiod consumption-investment decisions. Am. Econ. Rev. 60:1163–74 [Google Scholar]
  35. Fama EF. 1991. Efficient capital markets: II. J. Finance 46:51575–617 [Google Scholar]
  36. Fama EF, French KR. 1992. The cross-section of expected stock returns. J. Finance 47:427–65 [Google Scholar]
  37. Fama EF, French KR. 1993. Common risk factors in the returns on stocks and bonds. J. Financ. Econ. 33:3–56 [Google Scholar]
  38. Ferson WE, Harvey CR. 1991. The variation of economic risk premiums. J. Polit. Econ. 99:2385–415 [Google Scholar]
  39. Ferson WE, Harvey CR. 1999. Conditioning variables and the cross section of stock returns. J. Finance 54:41325–60 [Google Scholar]
  40. Flavin MA. 1981. The adjustment of consumption to changing expectations about future income. J. Polit. Econ. 89:5974–1009 [Google Scholar]
  41. French KR. 2015. Current research returns Tuck Sch. Bus., Dartmouth Univ. http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html [Google Scholar]
  42. Garman M. 1977. A general theory of asset valuation under diffusion state processes Work. Pap. 50, Univ. Calif. Berkeley [Google Scholar]
  43. Grauer FL, Litzenberger RH. 1979. The pricing of commodity futures contracts, nominal bonds and other risky assets under commodity price uncertainty. J. Finance 34:169–83 [Google Scholar]
  44. Grossman SJ, Melino A, Shiller RJ. 1987. Estimating the continuous-time consumption-based asset-pricing model. J. Bus. Econ. Stat. 5:3315–27 [Google Scholar]
  45. Grossman SJ, Shiller RJ. 1981. The determinants of the variability of stock market prices. J. Financ. Econ. 10:195–210 [Google Scholar]
  46. Hakansson NH. 1970. Optimal investment and consumption strategies under risk for a class of utility functions. Econometrica 38:5587–607 [Google Scholar]
  47. Hall RE. 1979. Stochastic implications of the life cycle-permanent income hypothesis: theory and evidence. J. Polit. Econ. 86:6971–87 [Google Scholar]
  48. Hall RE. 1988. Intertemporal substitution in consumption. J. Polit. Econ. 96:339–57 [Google Scholar]
  49. Hansen LP. 1982. Large sample properties of generalized method of moments estimators. Econometrica 50:41029–54 [Google Scholar]
  50. Hansen LP, Jagannathan R. 1991. Implications of security market data for models of dynamic economies. J. Polit. Econ. 99:225–62 [Google Scholar]
  51. Hansen LP, Singleton KJ. 1982. Generalized instrumental variables estimation of nonlinear rational expectations models. Econometrica 50:51269–86 [Google Scholar]
  52. Hansen LP, Singleton KJ. 1983. Stochastic consumption, risk aversion, and the temporal behavior of asset returns. J. Polit. Econ. 91:2249–65 [Google Scholar]
  53. Harvey CR. 1988. The real term structure and consumption growth. J. Financ. Econ. 22:2305–33 [Google Scholar]
  54. Harvey CR. 1989a. Forecasts of economic growth from bond and stock markets. Financ. Anal. J. 45:538–45 [Google Scholar]
  55. Harvey CR. 1989b. Time-varying conditional covariances in tests of asset pricing models. J. Financ. Econ. 24:289–317 [Google Scholar]
  56. Harvey CR. 1991a. The term structure and world economic growth. J. Fixed Income 1:17–19 [Google Scholar]
  57. Harvey CR. 1991b. The world price of covariance risk. J. Finance 46:1111–57 [Google Scholar]
  58. Harvey CR, Siddique A. 2000. Conditional skewness in asset pricing tests. J. Finance 55:31263–95 [Google Scholar]
  59. Heaton J, Lucas D. 1992. The effects of incomplete insurance markets and trading costs in a consumption-based asset pricing model. J. Econ. Dyn. Control 16:3601–20 [Google Scholar]
  60. Heaton J, Lucas D. 1996. Evaluating the effects of incomplete markets on risk sharing and asset pricing. J. Polit. Econ. 104:443–87 [Google Scholar]
  61. Hirshleifer J. 1970. Investment, Interest and Capital Englewood Cliffs, NJ: Prentice-Hall [Google Scholar]
  62. Huang C-F, Litzenberger RH. 1988. Foundations for Financial Economics New York: Elsevier [Google Scholar]
  63. Jagannathan R, Wang Z. 1996. The conditional CAPM and the cross-section of expected returns. J. Finance 51:13–53 [Google Scholar]
  64. Jagannathan R, Wang Y. 2007. Lazy investors, discretionary consumption, and the cross-section of stock returns. J. Finance 62:41623–61 [Google Scholar]
  65. Kocherlakota NR. 1990. Disentangling the coefficient of relative risk aversion from the elasticity of intertemporal substitution: an irrelevance result. J. Finance 45:1175–90 [Google Scholar]
  66. Kraus A, Litzenberger RH. 1976. Skewness preference and the valuation of risk assets. J. Finance 31:41085–100 [Google Scholar]
  67. Kraus A, Litzenberger RH. 1983. On the distributional conditions for a consumption-oriented three moment CAPM. J. Finance 38:51381–91 [Google Scholar]
  68. Lettau M, Ludvigson SC. 2001a. Consumption, aggregte weath, and expected stock returns. J. Finance 56:3815–49 [Google Scholar]
  69. Lettau M, Ludvigson SC. 2001b. Resurrecting the (C)CAPM: a cross-sectional test when risk premia are time-varying. J. Polit. Econ. 109:61238–87 [Google Scholar]
  70. Liew J, Vassalou M. 2000. Can book-to-market, size and momentum be risk factors that predict economic growth?. J. Financ. Econ. 57:2221–45 [Google Scholar]
  71. Lintner J. 1965. Valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Rev. Econ. Stat. 47:13–37 [Google Scholar]
  72. Lo AW. 2007. Dynamic Asset Pricing Models Northampton, MA: Edward Elgar [Google Scholar]
  73. Lo AW, MacKinlay C. 1990. Data-snooping biases in tests of financial asset pricing models. Rev. Financ. Stud. 3:431–69 [Google Scholar]
  74. Lucas RE. 1978. Asset prices in an exchange economy. Econometrica 46:61429–45 [Google Scholar]
  75. Malloy CJ, Moskowitz TJ, Vissing-Jørgensen A. 2009. Long-run stockholder consumption risk and asset returns. J. Finance 64:62427–79 [Google Scholar]
  76. Mankiw NG, Shapiro MD. 1986. Risk and return: consumption beta versus market beta. Rev. Econ. Stat. 68:3452–59 [Google Scholar]
  77. Mankiw NG, Zeldes SP. 1991. The consumption of stockholders and nonstockholders. J. Financ. Econ. 29:197–112 [Google Scholar]
  78. Mehra R, Prescott EC. 1985. The equity premium: a puzzle. J. Monet. Econ. 15:2145–61 [Google Scholar]
  79. Merton RC. 1969. Lifetime portfolio selection under uncertainty: the continuous-time case. Rev. Econ. Stat. 51:3247–57 [Google Scholar]
  80. Merton RC. 1971. Optimum consumption and portfolio rules in a continuous-time model. J. Econ. Theory 3:4373–413 [Google Scholar]
  81. Merton RC. 1973. An intertemporal capital asset pricing model. Econometrica 41:5867–87 [Google Scholar]
  82. Merton RC. 1992. Continuous-Time Finance Hoboken, NJ: Blackwell [Google Scholar]
  83. Newey W, West K. 1987. A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent covariance matrix. Econometrica 55:703–8 [Google Scholar]
  84. Nielsen NC. 1974. The firm as an intermediary between consumers and production functions under uncertainty PhD Thesis, Stanford Univ. [Google Scholar]
  85. Parker JA, Julliard C. 2005. Consumption risk and the cross section of expected returns. J. Polit. Econ. 113:1185–222 [Google Scholar]
  86. Petkova R, Zhang I. 2005. Is value riskier than growth?. J. Financ. Econ. 78:1187–202 [Google Scholar]
  87. Rietz T. 1988. The equity risk premium: a solution. J. Monet. Econ. 22:117–31 [Google Scholar]
  88. Ross SA. 1976. The arbitrage theory of capital asset pricing. J. Econ. Theory 3:343–63 [Google Scholar]
  89. Ross SA. 1976. Options and efficiency. Q. J. Econ. 90:175–89 [Google Scholar]
  90. Ross SA. 2005. Neoclassical Finance Princeton, NJ: Princeton Univ. Press [Google Scholar]
  91. Rubinstein M. 1974. An aggregation theorem for securities markets. J. Financ. Econ. 1:225–44 [Google Scholar]
  92. Rubinstein M. 1976. The valuation of uncertain income streams and the ricing of options. Bell. J. Econ. Manag. Sci. 7:2407–25 [Google Scholar]
  93. Rubinstein M. 1981. Discrete-time synthesis of financial theory Work. Pap. 20, 21, Res. Progr. Finance, Univ. Calif. Berkeley [Google Scholar]
  94. Samuelson PA. 1969. Lifetime portfolio selection by dynamic stochastic programming. Rev. Econ. Stat. 51:3239–46 [Google Scholar]
  95. Sharpe WF. 1964. Capital asset prices: a theory of asset pricing under conditions of risk. J. Finance 19:429–42 [Google Scholar]
  96. Shiller RJ. 1982. Consumption, asset markets and macroeconomic fluctuations. Carnegie-Rochester Conf. Public Policy 17:203–38 [Google Scholar]
  97. Stulz R. 1981. A model of international asset pricing. J. Financ. Econ. 9:383–406 [Google Scholar]
  98. Sundaresan SM. 1984. Consumption and equilibrium interest rates in stochastic production economies. J. Finance 39:177–92 [Google Scholar]
  99. US Dep. Commerce 1975. Historical Statistics of the United States: Colonial Times to 1970. Washington, DC: US Gov. Print. Off. [Google Scholar]
  100. Vissing-Jørgensen A. 2002. Limited asset market participation and the elasticity of intertemporal substitution. J. Polit. Econ. 110:4825–53 [Google Scholar]
  101. Wachter JA. 2006. A consumption-based model of the term structure of interest rates. J. Financ. Econ. 79:2365–99 [Google Scholar]
  102. Wheatley S. 1988. Some tests of the consumption-based asset pricing model. J. Monet. Econ. 22:2193–215 [Google Scholar]
/content/journals/10.1146/annurev-financial-111914-041800
Loading
/content/journals/10.1146/annurev-financial-111914-041800
Loading

Data & Media loading...

  • Article Type: Review Article
This is a required field
Please enter a valid email address
Approval was a Success
Invalid data
An Error Occurred
Approval was partially successful, following selected items could not be processed due to error