Testing Consumption-Based CAPM: Evidence from Alternative Models

24 Pages Posted: 15 Aug 2011

See all articles by Bin Li

Bin Li

Griffith University - Department of Accounting, Finance and Economics

Ali F. Darrat

Louisiana Tech University - College of Business

Philip Gray

Department of Banking and Finance, Monash University

Date Written: August 15, 2011

Abstract

Despite its intuitive appeal, empirical evidence on the consumption-based CAPM remains unclear at best. Model restrictions are often rejected, parameters are estimated imprecisely, and inferences can be highly sensitive to model specifications and choice of instruments. This paper tests the fit of the classic C-CAPM and three model extensions against various Australian asset classes. There is very little prior work examining the success of the C-CAPM in an Australian context, and the few existing studies are restricted to the classic C-CAPM. Our results provide some support for the C-CAPM, especially in relation to equity returns. When using instruments, the model implied restrictions cannot be rejected for market indexes, industry portfolios and portfolios cross-sorted on size and book-to-market. However, the evidence rejects the C-CAPM restrictions for size-sorted portfolios and for fixed-income returns. Our results also cast some doubts on the comparative advantage of various extensions of the classic C-CAPM such as habit-persistence and recursive utility models. These model extensions bring significant complexity and computational challenges but without much improvement in the model fit over the classic C-CAPM. Moreover, these extensions, like the classic C-CAPM, also fail to price small stock portfolios and fixed-income assets.

Keywords: consumption CAPM, GMM, habit formation, recursive utility

JEL Classification: G12

Suggested Citation

Li, Bin and Darrat, Ali F. and Gray, Philip, Testing Consumption-Based CAPM: Evidence from Alternative Models (August 15, 2011). Available at SSRN: https://ssrn.com/abstract=1909685 or http://dx.doi.org/10.2139/ssrn.1909685

Bin Li (Contact Author)

Griffith University - Department of Accounting, Finance and Economics ( email )

Nathan
Brisbane, Queensland, 4111
Australia

Ali F. Darrat

Louisiana Tech University - College of Business ( email )

Department of Economics & Finance
P.O. Box 10318
Ruston, LA 71272
United States
318-257-3874 (Phone)
318-257-4253 (Fax)

Philip Gray

Department of Banking and Finance, Monash University ( email )

Building H
Caulfield, Victoria 3141
Australia

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