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Consumption-Based Asset Pricing Models

Author

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  • Rajnish Mehra

    (Department of Economics and Finance, Arizona State University, Tempe, Arizona 85287
    Luxembourg School of Finance, University of Luxembourg, L-1468 Luxembourg, National Bureau of Economic Research, Cambridge, Massachusetts 02138)

Abstract

A major research initiative in finance focuses on the determinants of the cross-sectional and time series properties of asset returns. With that objective in mind, asset pricing models have been developed, starting with the capital asset pricing models of Sharpe (1964), Lintner (1965), and Mossin (1966). Consumption-based asset pricing models use marginal rates of substitution to determine the relative prices of the date, event-contingent, composite consumption good. This model class is characterized by a stochastic discount factor process that puts restrictions on the joint process of asset returns and per capita consumption. This review takes a critical look at this class of models and their inability to rationalize the statistics that have characterized US financial markets over the past century. The intuition behind the discrepancy between model prediction and empirical data is explained. Finally, the research efforts to enhance the model's ability to replicate the empirical data are summarized.

Suggested Citation

  • Rajnish Mehra, 2012. "Consumption-Based Asset Pricing Models," Annual Review of Financial Economics, Annual Reviews, vol. 4(1), pages 385-409, October.
    • Handle: RePEc:anr:refeco:v:4:y:2012:p:385-409
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    File URL: http://www.annualreviews.org/doi/abs/10.1146/annurev-financial-102710-144825
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    More about this item

    Keywords

    equity premium puzzle; life cycle; borrowing constraints; retirement;
    All these keywords.

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G1 - Financial Economics - - General Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • H0 - Public Economics - - General
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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