Consumption-Based Asset Pricing Models

Rajnish Mehra

Annual Review of Financial Economics, 2012, vol. 4, issue 1, 385-409

Abstract: A major research initiative in finance focuses on the determinants of the cross-sectional and time series properties of asset returns. With that objective in mind, asset pricing models have been developed, starting with the capital asset pricing models of Sharpe (1964), Lintner (1965), and Mossin (1966). Consumption-based asset pricing models use marginal rates of substitution to determine the relative prices of the date, event-contingent, composite consumption good. This model class is characterized by a stochastic discount factor process that puts restrictions on the joint process of asset returns and per capita consumption. This review takes a critical look at this class of models and their inability to rationalize the statistics that have characterized US financial markets over the past century. The intuition behind the discrepancy between model prediction and empirical data is explained. Finally, the research efforts to enhance the model's ability to replicate the empirical data are summarized.

Keywords: equity premium puzzle; life cycle; borrowing constraints; retirement (search for similar items in EconPapers)
JEL-codes: D31 E2 E21 E44 G1 G11 G12 G23 H0 H62 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (39)

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