Essay: Consumption-based capital asset pricing model (CCAPM)

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  • Consumption-based capital asset pricing model (CCAPM)
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The consumption-based capital asset pricing model (CCAPM) was established in 1978, by Lucas and Breeden. They described their model to the consumer as being the model where the relative risk aversion coefficient was constant.
Then Mankiw and Shapiro (1986) arrived with this claim that a consumption beta could take on the role of risk criteria and tested this model on the New York Stock Exchange (NYSE).
Also Kocherlakota (1996) showed the integral role of advanced macroeconomics and international economics, in reality, is more significant in the CAPM than in the CCAPM. In addition to the findings of Hansen & Singleton (1982), Mehra & Prescott (1985), Mankiw & Zeldes (1991), and Campbell (1993, 1996), literature in the context of the CCAPM showed that the Lucas standard CCAPM has been able to explain Return on Assets in the United States.
Additionally Cumby (1990) also showed that this model (CCAPM) could explain the international stock market. In addition to the above findings, Hamorin (1992) also showed that CCAPM could have an important role in the capital market of Japan.
Of the others studies on CCAPM, one could point out the Asprem (1989) studies. He suggested using import instead of consumption.
Ming Siangchen (2003), did a comparison between the CAPM and the CCAPM in the Taiwan stock market. He concluded that in all cases of the power of explanatory the traditional CAPM model was superior to the CCAPM model.
Gregoriouand Ioannidis (2006) tested the CCAPM model in the British stock market by entering the variable cost of transactions in this model. It was concluded that by using the seasonal return during the period 1980 to 2000, although this model could not explain the stock return, the variable transaction cost was significant in all cases and should be considered for this model.
Karagyozova (2007) tested the CCAPM model in the Great Britain stock market by dividing the shareholders in the market into two groups of A and B. The results showed that the performance of these two groups was different and had different effects on the CCAPM.
Bach and Moller (2011) in their article estimated the asset pricing model based on consumption, with limited participation of consumption, formation, and habits. Their study was conducted on a sample of US households, In this sample, there were two groups: Those who hold shares and those who did not hold shares. It was shown that the consumption of those who held shares was higher in performance than those who did not hold shares. In addition, it was shown that a high volatility of consumption of those who held shares enabled the model to explain the equity premium puzzle and the risk-free rate puzzle together for a reasonable value of relative risk aversion.
Kang et al. (2011) in their article, developed a kind of conditional capital asset pricing model (CAPM), where they used the conditional variable and this variable had a high power of forecasting the expected excess return on the market. This coIto andnditioning variable was obtained from the co-integrating relation among the macroeconomic variables (dividend yield, term spread, default spread, and short-term interest rate). The results showed that the value stocks were riskier than growth stocks in bad times, supporting the risk-based story.
Ito and Noda (2011), in a study, estimated the parameters of the CCAPM for the Japanese economy. They used the method of Hansen (1990) that is the famous generalized the empirical likelihood (GEL). These parameters varied over time in this estimation. The experimental results and the CCAPM parameters showed a degree of risk aversion. In addition to the above findings the results showed that the discount rate was variable over time.
Xiao et al. (2012) re-evaluated the cross-sectional asset pricing implications of the recursive utility function of Epstein and Zin (1989, 1991), their empirical specification helped to explain the size, value, and momentum effects.
Jinyong Kim (2012) has dealt with the CAPM multivariate. This article questions whether the superior empirical performance of the multifactor CCAPM is maintained once the time-series intercept restrictions are explicitly tested. The maximum correlation portfolio (MCP) approach is employed to implement the intercept restrictions. The empirical findings support the conclusion that multifactor CCAPMs can explain the cross-section of the expected stock returns better than the classic unconditional models.
Dreyer et al. (2013) have made adjustments in the CCAPM model and presented their article as “savings based pricing”. This article explores the implications of a novel class of preferences for the behavior of asset prices. Following a suggestion by Marshall (1920), they drove the Euler equations for these preferences and estimated them with generalized method of moments (GMM). their estimations suggest that the preference for saving is economically significant.
Auer (2013), in an article, deals with the ‘formation of habits’ model of Campbell and Cochrane (1999). He has tested the conditional covariance representation of the model using a combined Generalized AutoRegressive Conditional Heteroskedasticity (GARCH) and GMM approach in the spirit of Bali (2008), and he has found that in comparison to the CAPM and the standard power utility CCAPM, the habit model has superior explanatory power. It explains more than 90% of the cross-sectional variation in risk premium.
Ho Kim (2014) has proposed a consistent estimator of time-varying risk aversion in the consumption-based CAPM. Based on the Epstein—Zin—Weil (Epstein and Zin, 1989, 1991;Weil, 1989) recursive utility, the Euler equation was derived in this article, wheein risk aversion is a non-parametric function of time. The proxy variable method is utilized to replace the unobserved return to aggregate wealth in the Euler equation. The empirical results strongly support the counter cyclicality of the risk aversion parameter.
Fung et al. (2014) in an article, investigated the capital asset pricing model. They have started their research with introduction by Bansal and Yaron (2004). They have shown that the conditional equity premium is a linear function of conditional consumption and market return volatilities, which can be estimated conveniently by various GARCH and Stochastic Volatility (SV) models. The Exponential GARCH (EGARCH) volatility can explain up to 55% of the variation of return and the EGARCH model augmented with cay (a co-integrating factor of consumption, labor income, and asset wealth growth) greatly enhances the model’s performance.
Huang, Wu, Zhang (2014) has developed a CCAPM model with a separate goods market and overseas market. In this model, the exchange rate influences the asset prices through the marginal utility of consumption and increases the risks investors face. They find that the model can successfully price the 25 Fama—French portfolios and industry portfolios in the Chinese market, and the exchange rate is an important pricing factor in the unconditional linear model.
Márquez et al. (2014) expanded the CCAPM model by entering the liquidity shocks. Their article derived closed-form expressions for consumption-based stochastic discount factors adjusted by market-wide illiquidity shocks. This adjustment was considered both a contemporaneous and ultimate consumption risk. They found a large and highly significant illiquidity risk premium for the first quarter of the year, suggesting a time-varying behavior of the market-wide illiquidity premium.

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