Can consumption-based asset pricing models explain the cross-section of investment funds returns?

Using the parametric Generalized Method of Moments (GMM) methodology of Hansen (1982) and the nonparametric approach of Hansen and Jagannathan (1991), this note investigates the ability of Consumption-based Asset Pricing Models (CCAPMs) to explain the cross-section of investment funds returns in the German market. The parametric analysis shows that both the classic power utility model of Hansen and Singleton (1982) and the habit formation extension of Campbell and Cochrane (1999) are not rejected, but require high risk-aversion to be consistent with the data. Furthermore, only the power utility model suffers from a risk-free rate puzzle. The nonparametric results are not accompanied by a risk-free rate puzzle for both models but the models still show high risk aversion. So using adequate test assets and evaluation methods, this note fully supports Cochrane (2006) saying that work explaining asset returns with consumption-based models should be dying out since there are preferences that can coherently describe the data with high risk-aversion.