Do Consumption-Based Asset Pricing Models Explain the Dynamics of Stock Market Returns?

Michael William Ashby () and Oliver Linton
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Michael William Ashby: Faculty of Economics, Downing College, University of Cambridge, Cambridge CB2 1TN, UK

JRFM, 2024, vol. 17, issue 2, 1-41

Abstract: We show that three prominent consumption-based asset pricing models—the Bansal–Yaron, Campbell–Cochrane and Cecchetti–Lam–Mark models—cannot explain the dynamic properties of stock market returns. We show this by estimating these models with GMM, deriving ex-ante expected returns from them and then testing whether the difference between realised and expected returns is a martingale difference sequence, which it is not. Mincer–Zarnowitz regressions show that the models’ out-of-sample expected returns are systematically biased. Furthermore, semi-parametric tests of whether the models’ state variables are consistent with the degree of own-history predictability in stock returns suggest that only the Campbell–Cochrane habit variable may be able to explain return predictability, although the evidence on this is mixed.

Keywords: performance of asset pricing models; consumption-based asset pricing models; serial correlation; predictability; martingale difference sequence; variance ratio; quantilogram; rescaled range; power spectrum; Mincer–Zarnowitz regression; MIDAS (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2024
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