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An alternative representation of the C-CAPM with higher-order risks

Author

Listed:
  • Georges Dionne

    (HEC Montréal)

  • Jingyuan Li

    (Lingnan University)

  • Cédric Okou

    (International Monetary Fund)

Abstract

This paper exploits the concept of expectation dependence to propose an alternative representation of the consumption-based capital asset pricing model (C-CAPM). While the first-degree expectation dependence (FED) drives the C-CAPM’s riskiness for a risk-averse investor, the second-degree expectation dependence (SED) is required to account for the downside risk faced by a prudent investor. Theoretical and empirical assessments reveal that the expectation dependence-based C-CAPM can realistically match equity and variance risk premia. The consumption SED risk emerges as a fundamental source of uncertainty driving asset prices.

Suggested Citation

  • Georges Dionne & Jingyuan Li & Cédric Okou, 2024. "An alternative representation of the C-CAPM with higher-order risks," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 49(2), pages 194-233, September.
    • Handle: RePEc:pal:genrir:v:49:y:2024:i:2:d:10.1057_s10713-023-00085-2
    DOI: 10.1057/s10713-023-00085-2
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    More about this item

    Keywords

    C-CAPM; Expectation dependence; Higher-order risk; Equity risk premium; Variance risk premium;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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