Resurrecting the (C)CAPM: a cross-sectional test when risk premia are time-varying
Martin Lettau () and
Sydney Ludvigson ()
No 93, Staff Reports from Federal Reserve Bank of New York
This paper explores the ability of theoretically based asset pricing models such as the CAPM and the consumption CAPM-referred to jointly as the (C)CAPM - to explain the cross-section of average stock returns. Unlike many previous empirical tests of the (C)CAPM, we specify the pricing kernel as a conditional linear factor model, as would be expected if risk premia vary over time. Central to our approach is the use of a conditioning variable which proxies for fluctuations in the log consumption-aggregate wealth ratio and is likely to be important for summarizing conditional expectations of excess returns. We demonstrate that such conditional factor models are able to explain a substantial fraction of the cross-sectional variation in portfolio returns. These models perform much better than unconditional (C)CAPM specifications, and about as well as the three-factor Fama-French model on portfolios sorted by size and book-to-market ratios. This specification of the linear conditional consumption CAPM, using aggregate consumption data, is able to account for the difference in returns between low book-to-market and high book-to-market firms and exhibits little evidence of residual size or book-to-market effects.
Keywords: Rate of return; Asset pricing (search for similar items in EconPapers)
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Journal Article: Resurrecting the (C)CAPM: A Cross-Sectional Test When Risk Premia Are Time-Varying (2001)
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