The Predictability Implied by Consumption-Based Asset Pricing Models
The Predictability Implied by Consumption-Based Asset Pricing Models

Author: Jiun-Lin Chen

Publisher:

Published: 2018

Total Pages: 32

ISBN-13:

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The consumption-based models have a lack of predictive power for explaining variability of stock returns. This paper examines two well-known models, Campbell and Cochrane (1999)'s habit model and Bansal and Yaron (2004)'s long-run risks model, to see whether they produce a significant power of return predictability. For the habit model, empirical tests reveal that the state variable, the surplus consumption ratio, explains counter-cyclical time-varying expected returns. The long-run risks model also proves to explain that main sources of volatility in price-dividend ratio are a persistent and predictable consumption growth rate and fluctuating economic uncertainty. The models are also tested by following the work of Kirby (1998) whether they can explain the observed return predictability. Both models fail to generate any significant predictive power. The habit model is relatively strong in volatility, which implies that variation in expected excess return is largely attributable to the time-varying risk aversion.

The Restrictions on Predictability Implied by Rational Asset Pricing Models
The Restrictions on Predictability Implied by Rational Asset Pricing Models

Author: Chris Kirby

Publisher:

Published: 2001

Total Pages:

ISBN-13:

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This article shows how rational asset pricing models restrict the regression-based criteria commonly used to measure return predictability. Specifically, it invokes no arbitrage arguments to show that the intercept, slope coefficients, and R-squared in predictive regressions must take specific values. These restrictions provide a way to directly assess whether the predictability uncovered using regression analysis is consistent with rational pricing. Empirical tests reveal that the returns on the CRSP size deciles are too predictable to be compatible with a number of well-known pricing models. However, the overall pattern of predictability across these portfolios is reasonably consistent with what we would expect under circumstances where predictability is rational.

Asset Pricing
Asset Pricing

Author: John H. Cochrane

Publisher: Princeton University Press

Published: 2009-04-11

Total Pages: 560

ISBN-13: 1400829135

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Winner of the prestigious Paul A. Samuelson Award for scholarly writing on lifelong financial security, John Cochrane's Asset Pricing now appears in a revised edition that unifies and brings the science of asset pricing up to date for advanced students and professionals. Cochrane traces the pricing of all assets back to a single idea--price equals expected discounted payoff--that captures the macro-economic risks underlying each security's value. By using a single, stochastic discount factor rather than a separate set of tricks for each asset class, Cochrane builds a unified account of modern asset pricing. He presents applications to stocks, bonds, and options. Each model--consumption based, CAPM, multifactor, term structure, and option pricing--is derived as a different specification of the discounted factor. The discount factor framework also leads to a state-space geometry for mean-variance frontiers and asset pricing models. It puts payoffs in different states of nature on the axes rather than mean and variance of return, leading to a new and conveniently linear geometrical representation of asset pricing ideas. Cochrane approaches empirical work with the Generalized Method of Moments, which studies sample average prices and discounted payoffs to determine whether price does equal expected discounted payoff. He translates between the discount factor, GMM, and state-space language and the beta, mean-variance, and regression language common in empirical work and earlier theory. The book also includes a review of recent empirical work on return predictability, value and other puzzles in the cross section, and equity premium puzzles and their resolution. Written to be a summary for academics and professionals as well as a textbook, this book condenses and advances recent scholarship in financial economics.

Frontiers of Business Cycle Research
Frontiers of Business Cycle Research

Author: Thomas F. Cooley

Publisher: Princeton University Press

Published: 1995-02-26

Total Pages: 452

ISBN-13: 9780691043234

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This introduction to modern business cycle theory uses a neoclassical growth framework to study the economic fluctuations associated with the business cycle. Presenting advances in dynamic economic theory and computational methods, it applies concepts to t

Global Stock Markets
Global Stock Markets

Author: Wolfgang Drobetz

Publisher: Springer Science & Business Media

Published: 2013-06-29

Total Pages: 346

ISBN-13: 3663085295

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Wolfgang Drobetz provides empirical evidence on the time variation of expected stock returns over the stages of the business cycle.

A Consumption Based Asset Pricing Model of the Yield Curve
A Consumption Based Asset Pricing Model of the Yield Curve

Author: Nathan Born

Publisher:

Published: 2015

Total Pages:

ISBN-13:

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This paper seeks to create a representative model of the yield curve by combining the standard consumption based asset pricing model used by Canzoneri, et al and the equation for the Pure Expectations Hypothesis of the Term Structure of Interest Rates. I begin with reviewing different theories of the yield curve. I then use consumption based asset pricing model in conjunction with the expectations hypothesis to see whether the models can accurately represent the data on yield curve slopes. I conclude with an examination of the forward looking aspects of the yield curve. I find that the forward-looking nature of the yield curve which is implied by the Expectations Hypothesis is not entirely reliable in predicting real GDP.

By Force of Habit
By Force of Habit

Author: John Y. Campbell

Publisher:

Published: 1995

Total Pages: 76

ISBN-13:

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We present a consumption-based model that explains the procyclical variation of stock prices, the long-horizon predictability of excess stock returns, and the countercyclical variation of stock market volatility. Our model has an i.i.d. consumption growth driving process, and adds a slow-moving external habit to the standard power utility function. The latter feature produces cyclical variation in risk aversion, and hence in the prices of risky assets. Our model also predicts many of the difficulties that beset the standard power utility model, including Euler equation rejections, no correlation between mean consumption growth and interest rates, very high estimates of risk aversion, and pricing errors that are larger than those of the static CAPM. Our model captures much of the history of stock prices, given only consumption data. Since our model captures the equity premium, it implies that fluctuations have important welfare costs. Unlike many habit-persistence models, our model does not necessarily produce cyclical variation in the risk free interest rate, nor does it produce an extremely skewed distribution or negative realizations of the marginal rate of substitution.

Evaluating Asset Pricing Models with Limited Commitment Using Household Consumption Data
Evaluating Asset Pricing Models with Limited Commitment Using Household Consumption Data

Author: Dirk Krueger

Publisher:

Published: 2007

Total Pages: 28

ISBN-13:

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We evaluate the asset pricing implications of a class of models in which risk sharing is imperfect because of limited enforcement of intertemporal contracts. Lustig (2004) has shown that in such a model the asset pricing kernel can be written as a simple function of the aggregate consumption growth rate and the growth rate of consumption of the set of households that do not face binding enforcement constraints. These unconstrained households have lower consumption growth rates than all other households in the economy. We use household data on consumption growth from the U.S. Consumer Expenditure Survey to identify unconstrained households, to estimate the pricing kernel implied by these models and evaluate their performance in pricing aggregate risk. We find that for high values of the relative risk aversion coefficient, the limited enforcement pricing kernel generates a market price of risk that is substantially closer to the data than the one obtained using the standard complete markets asset pricing kernel.

Predictability in Consumption Growth and Equity Returns
Predictability in Consumption Growth and Equity Returns

Author: George Theocharides

Publisher:

Published: 2009

Total Pages: 60

ISBN-13:

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We estimate a widely cited consumption-based asset pricing model using fully Bayesian MCMC method. Although the model is generally consistent with consumption and dividend growth moments in annual data, the conditional mean of consumption growth (a latent process) is not persistent enough to satisfy the model's restriction that the price/dividend ratio be an affine function of the latent process. We argue that this lack of persistence in the latent process may result in equity volatility puzzle. The model accounts for only 50% of total variation in asset returns. The model can explain equity premium at a cost of high risk aversion. We also find that a one-factor nature of the model implies zero predictability of excess equity returns by price/dividend ratios.