Explaining the Poor Performance of Consumption‐based Asset Pricing Models

John Campbell and John Cochrane

Journal of Finance, 2000, vol. 55, issue 6, 2863-2878

Abstract: We show that the external habit‐formation model economy of Campbell and Cochrane (1999) can explain why the Capital Asset Pricing Model (CAPM) and its extensions are betterapproximate asset pricing models than is the standard onsumption‐based model. The model economy produces time‐varying expected eturns, tracked by the dividend–price ratio. Portfolio‐based models capture some of this variation in state variables, which a state‐independent function of consumption cannot capture. Therefore, though the consumption‐based model and CAPM are both perfect conditional asset pricing models, the portfolio‐based models are better approximate unconditional asset pricing models.

Date: 2000
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https://doi.org/10.1111/0022-1082.00310

Related works:
Working Paper: Explaining the Poor Performance of Consumption-Based Asset Pricing Models (2000)
Working Paper: Explaining the Poor Performance of Consumption-Based Asset Pricing Models (1999)
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