Consumption-Based Asset Pricing, Part 1: Classic Theory and Tests, Measurement Issues, and Limited Participation

Douglas T. Breeden (), Robert H. Litzenberger and Tingyan Jia ()
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Douglas T. Breeden: Fuqua School of Business, Duke University, Durham, North Carolina 27708
Robert H. Litzenberger: The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104
Tingyan Jia: Graduate School of Business, Stanford University, Stanford, California 94305

Annual Review of Financial Economics, 2015, vol. 7, issue 1, 35-83

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.

Keywords: aggregation; asset pricing; consumption CAPM; equity premium; interest rates; limited participation (search for similar items in EconPapers)
JEL-codes: D91 E21 G12 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (13)

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