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Explaining the Poor Performance of Consumption-Based Asset Pricing Models

John Campbell () and John Cochrane ()

Scholarly Articles from Harvard University Department of Economics

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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Published in Journal of Finance

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Journal Article: Explaining the Poor Performance of Consumption-based Asset Pricing Models (2000) Downloads
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