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Consumption-Based Asset Pricing, Part 1: Classic Theory and Tests, Measurement Issues, and Limited Participation

Author

Listed:
  • Douglas T. Breeden

    (Fuqua School of Business, Duke University, Durham, North Carolina 27708)

  • Robert H. Litzenberger

    (The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104)

  • Tingyan Jia

    (Graduate School of Business, Stanford University, Stanford, California 94305)

Abstract

This article, Part 1 of 2, reviews the classical origins, development, and tests of consumption-based asset pricing theory, focusing mainly on the first two decades from 1976 to 1998. Starting with the original consumption capital asset pricing model (CCAPM) derivations, we review both theory and subsequent tests and provide some new applications. The consumption aggregation theorem and CCAPM are derived, and optimal consumption and portfolio strategies are discussed. The term structure of interest rates is derived from the term structures for expected growth, volatility, and inflation. Time aggregation biases in consumption betas as well as the usefulness of the “consumption-mimicking portfolio” are also derived. In addition to various empirical tests, models and tests of limited participation in asset markets as well as models of incomplete markets are presented. When certain measurement issues are taken into account, the CCAPM performs better than the original CAPM and nearly as well as the Fama-French three-factor model.

Suggested Citation

  • Douglas T. Breeden & Robert H. Litzenberger & Tingyan Jia, 2015. "Consumption-Based Asset Pricing, Part 1: Classic Theory and Tests, Measurement Issues, and Limited Participation," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 35-83, December.
    • Handle: RePEc:anr:refeco:v:7:y:2015:p:35-83
    DOI: 10.1146/annurev-financial-111914-041800
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    Citations

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    Cited by:

    1. Grasso, Adriana & Natoli, Filippo, 2018. "Consumption volatility risk and the inversion of the yield curve," Working Paper Series 2141, European Central Bank.
    2. Ling-Ni Boon & Florian Ielpo, 2016. "An anatomy of global risk premiums," Journal of Asset Management, Palgrave Macmillan, vol. 17(4), pages 229-243, July.
    3. Djeutem Edouard & Nguimkeu Pierre, 2020. "Robust learning in the foreign exchange market," The B.E. Journal of Macroeconomics, De Gruyter, vol. 20(1), pages 1-14, January.
    4. Michael Falkenheim, 2021. "Governmental Risk Taking Under Market Imperfections: Working Paper 2021-07," Working Papers 57255, Congressional Budget Office.
    5. Hultkrantz, Lars & Mantalos, Panagiotis, 2018. "Hedging with trees: Tail-hedge discounting of long-term forestry returns," Journal of Forest Economics, Elsevier, vol. 30(C), pages 52-57.
    6. Òscar Jordà & Moritz Schularick & Alan M. Taylor, 2019. "The Total Risk Premium Puzzle," NBER Working Papers 25653, National Bureau of Economic Research, Inc.
    7. Ashley Lim & Yihui Lan & Sirimon Treepongkaruna, 2020. "Asset pricing and energy consumption risk," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(4), pages 3813-3850, December.
    8. Indrajit Mitra & Yu Xu, 2020. "Limited Household Risk Sharing: General Equilibrium Implications for the Term Structure of Interest Rates," FRB Atlanta Working Paper 2020-20, Federal Reserve Bank of Atlanta.
    9. Calvet, Laurent-Emmanuel & Grandmont, Jean-Michel & Lemaire, Isabelle, 2018. "Aggregation of heterogenous beliefs, asset pricing, and risk sharing in complete financial markets," Research in Economics, Elsevier, vol. 72(1), pages 117-146.

    More about this item

    Keywords

    aggregation; asset pricing; consumption CAPM; equity premium; interest rates; limited participation;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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