Consumption-Based Asset Pricing, Part 2: Habit Formation, Conditional Risks, Long-Run Risks, and Rare Disasters

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, 85-131

Abstract: Following Part 1 of this article, which reviews late-1970s to 1990s classic derivations and tests of the consumption capital asset pricing model, here in Part 2 we review more recent developments, some of which are based on utility functions with non-time-separable preferences. Important second-generation consumption-based asset pricing advances are also reviewed, including models with habit formation and long-run risk. These models give large cyclical changes in relative risk aversion and risk premiums as well as lagged impacts of aggregate consumption changes on risk premiums. We review asset pricing with rare disasters and models focused on consumer spending on durables and real estate, as well as the fraction of spending financed by labor income. The second-generation models discussed have more free parameters and fit the empirical data better than did the first-generation consumption-based asset pricing models.

Keywords: asset pricing; CCAPM; consumption; habit formation; long-run risk; nonseparable preferences; rare disasters (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 (6)

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