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Explaining the Poor Performance of Consumption-Based Asset Pricing Models

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  • Campbell, John
  • Cochrane, John

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.

Suggested Citation

  • Campbell, John & Cochrane, John, 2000. "Explaining the Poor Performance of Consumption-Based Asset Pricing Models," Scholarly Articles 3163265, Harvard University Department of Economics.
    • Handle: RePEc:hrv:faseco:3163265
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    References listed on IDEAS

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