From Which Consumption-Based Asset Pricing Models Can Investors Profit? Evidence from Model-Based Priors*

Are Stocks Riskier over the Long Run? Taking Cues from Economic Theory

Mathias S Kruttli

Journal of Financial Econometrics, 2022, vol. 20, issue 3, 539-567

Abstract: This article analyzes whether consumption-based asset pricing models improve the excess returns forecasts of a hypothetical investor with access to these models from 1947 onwards. The investor imposes economic constraints derived from asset pricing models as model-based priors on predictive regression parameters through a Bayesian framework. Three models are considered: habit formation, long-run risk, and prospect theory. The model-based priors generally perform better than priors that shrink the parameter estimates to the historical average model and priors that impose a positive equity premium. This analysis helps to assess the value of consumption-based asset pricing models to investors.

Keywords: return predictability; consumption-based asset pricing; Bayesian econometrics (search for similar items in EconPapers)
JEL-codes: G11 G12 G17 (search for similar items in EconPapers)
Date: 2022
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