Ashby, M. and Linton, O. B.
Do Consumption-Based Asset Pricing Models Explain the Dynamics of Stock Market Returns?
Journal of Risk and Financial Management
Vol. 17(12) (2024)
Abstract: We show that three prominent consumption-based asset pricing models—the Bansal–Yaron, Campbell–Cochrane and Cecchetti–Lam–Mark models—cannot explain the dynamic properties of stock market returns. We show this by estimating these models with GMM, deriving ex-ante expected returns from them and then testing whether the difference between realised and expected returns is a martingale difference sequence, which it is not. Mincer–Zarnowitz regressions show that the models’ out-of-sample expected returns are systematically biased. Furthermore, semi-parametric tests of whether the models’ state variables are consistent with the degree of own-history predictability in stock returns suggest that only the Campbell–Cochrane habit variable may be able to explain return predictability, although the evidence on this is mixed.
Keywords: consumption-based asset pricing models, martingale difference sequence, MIDAS, Mincer–Zarnowitz Regression, Performance of Asset Pricing Models, power spectrum, predictability, quantilogram, rescaled range, serial correlation, variance ratio
JEL Codes: C52, C58, G12
Author links: Oliver Linton Michael Ashby
Publisher's Link: https://doi.org/10.3390/jrfm17020071 