New Goods and Asset Prices

PurposeThis paper seeks to reconsider the Euler equation of the Consumption Capital Asset Pricing Model (CCAPM), to derive a regression‐based model to test it, and to present evidence that the model is consistent with reasonable values for the coefficient of relative risk aversion (CRRA). This runs contrary to the findings of the literature on the equity premium puzzle, but is in agreement with the literature that estimates the CRRA for the purpose of computing the social discount rate, and is in line with the research on labor supply. Tests based on General Method of Moments (GMM) for the same sample produce results that are extremely disparate and unstable. The paper aims to check and find support for the robustness of the regression‐based tests. Habit formation models are also to be evaluated with regression‐based and GMM tests. However, the validity of the regression‐based models depends critically on their functional forms.Design/methodology/approachThe paper presents empirical evidence that the conventional use of GMM fails because of four pathological features of GMM that are referred to under the general caption of “weak identification”. In addition to GMM, the paper employs linear regression analysis to test the CCAPM, and it is found that the regression residuals follow well‐behaved distributional properties, making valid all statistical inferences, while GMM estimates are highly unstable.FindingsFour unexpected findings are reported. The first is that the regression‐based models are consistent with reasonable values for the CRRA, i.e. estimates that are below 4. The second is that the regression‐based tests are robust, while the GMM‐based tests are not. The third is that regression‐based tests with habit formation depend crucially on the specification of the model. The fourth is that there is evidence that market stock returns are sensitive to both consumption and dividends. The author calls the latter “extra sensitivity of market stock returns”, and it is described as a new puzzle.Originality/valueThe regression‐based models of the CCAPM Euler equation are novel. The comparison between GMM and regression‐based models for the same sample is original. The regression‐based models with habit formation are new. The equity premium puzzle disappears because the estimates of the CRRA are reasonable. But another puzzle is documented, which is the “extra sensitivity of market stock returns” to consumption and dividends together.

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.

This paper analyzes asset prices in a representative agent exchange economy with habit-forming preferences. For a general class of utility indices and endowment processes, the authors characterize the optimal demand for consumption and derive explicit solutions for the interest rate and asset risk premia. They show that consumption smoothness may obtain even when the interest rate is stochastic. The consumption capital asset pricing model may not hold when the endowment process has stochastic coefficients; asset risk premia are larger under mild assumptions. The interest rate depends on the growth in the standard of living. Malliavin calculus is employed in the analysis. Copyright 1991 by The Econometric Society.

This paper proposes energy consumption in the US as a new measure for the consumption capital asset pricing model. We find that (i) industrial energy growth produces reasonable values for the relative risk aversion coefficient and the implied risk‐free rate; (ii) compared to alternative consumption measures, industrial energy performs well in explaining the cross‐sectional variation in stock returns with the lowest implied risk aversion and pricing errors; (iii) the industrial energy consumption risk model performs equally well as the Fama–French three‐factor model in the cross‐sectional asset pricing tests; and (iv) total energy consumption risk is priced in the presence of the Fama–French factor risks.

Consumption Risk Over the Frequency Domain

The purpose of this paper is to examine the theoretical relationship between the multidimensionality of risk and dividend policy, in an intertemporal context. After assuming that dividends are generated by a multifactor process, we use the fundamental framework of the consumption capital asset pricing model to explore the effect of long-run risk on dividend payout ratios (dividends divided by earnings). Our approach is similar to any multifactor model that, given the N factor process, derives useful equilibrium conditions. Our main result shows that the dividend payout ratio is negatively related to N sensitive coefficients, given by the long-run covariance between dividends and economic factors. This suggests that the multidimensionality of long-run consumption risk influences dividend policy. In brief, the model proposes that the target payout ratio can be determined with a simple and easy-to-apply formula that takes into account the long-run sensitivity of dividends to various economic factors.

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

Most single-factor and multifactor asset pricing models constitute special cases of the consumption-based asset pricing theory, in which investors’ marginal utility is the key determinant of asset prices. However, in recent years, production-based asset pricing models have been extraordinarily successful in correctly pricing a wide range of anomaly portfolios that are typically mispriced in previous research. In parallel, research on conditioning information has contributed to significantly improve the performance of classic consumption-based asset pricing models. On this basis, in this paper we conduct an in-depth research on the performance of consumption and production-based asset pricing models on the Tokyo Stock Exchange, for the period from 1992 to 2018, in order to test to what extent consumer confidence helps consumption models to correctly capture shifts in the investment opportunity set of investors. To overcome the constraints imposed by the periodicity of macroeconomic data, we use a factor-mimicking portfolio approach that allows us to test the performance of the models into consideration at different frequencies. Our results suggest that the consumer confidence index for Japan helps consumption-based asset pricing models outperform production-based models for different anomaly portfolios. Conversely, in those cases where consumption models perform worse, the production models also perform poorly. These results help to partially reconcile the results provided by the consumption and production models, and constitute a step forward for the purpose of identifying the fundamental risk factors that drive asset prices.

This article presents a pure exchange economy that extends Rubinstein [Bell J. Econ. Manage. Sci., 1976, 7, 407–425] to show how the jump-diffusion option pricing model of Black and Scholes [J. Political Econ., 1973, 81, 637–654] and Merton [J. Financ. Econ., 1976, 4, 125–144] evolves in gamma jumping economies. From empirical analysis and theoretical study, both the aggregate consumption and the stock price are unknown in determining jumping times. By using the pricing kernel, we determine both the aggregate consumption jump time and the stock price jump time from the equilibrium interest rate and CCAPM (Consumption Capital Asset Pricing Model). Our general jump-diffusion option pricing model gives an explicit formula for how the jump process and the jump times alter the pricing. This innovation with predictable jump times enhances our analysis of the expected stock return in equilibrium and of hedging jump risks for jump-diffusion economies.

We augment the standard Consumption Capital Asset Pricing Model (CCAPM) by the growth in money holdings and empirically investigate whether money is helpful for pricing a cross-section of US excess returns. We find that the growth in M2 significantly improves the fit of the CCAPM with R 2s well above 80% in a cross-section with the three Fama–French factors, the momentum portfolio, a contrarian portfolio and two bond portfolios as test assets.

This paper develops a method of using financial data to understand the expected impact of trade policy on welfare and other real variables when the policy has heterogeneous and uncertain impacts on firms. We embed a firm-level specific factors model in a consumption capital asset pricing model to map expected cash-flow movements into expected movements in productivity, wages, and welfare. Using our framework, we find that the U.S.-China trade war caused increases in uncertainty and large declines in U.S. stock prices, expected cash flows, and expected productivity. We estimate that the expected decline in U.S. welfare is 4.9 percentage points.

Local Identification of Nonparametric and Semiparametric Models

Bayesian analysis of the consumption CAPM

Wealth Effects in Europe: A Tale of Two Countries (Italy and the United Kingdom)

This paper analyses the interaction of inflation with nominal and real tax systems by incorporating each of a real tax system (which taxes only real asset returns) and a nominal tax system (which also taxes the inflation component) into the consumption capital asset pricing model. Abstracting from administrative costs, it is shown that a real tax system generally leads to a lesser distortion of consumption patterns and of asset returns than does a nominal tax system, even in an environment with zero expected inflation.