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Do Consumption-Based Asset Pricing Models Explain the Dynamics of Stock Market Returns?

Author

Listed:
  • Michael William Ashby

    (Faculty of Economics, Downing College, University of Cambridge, Cambridge CB2 1TN, UK)

  • Oliver Bruce Linton

    (Faculty of Economics, Trinity College, University of Cambridge, Cambridge CB2 1TN, UK)

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.

Suggested Citation

  • Michael William Ashby & Oliver Bruce Linton, 2024. "Do Consumption-Based Asset Pricing Models Explain the Dynamics of Stock Market Returns?," JRFM, MDPI, vol. 17(2), pages 1-41, February.
    • Handle: RePEc:gam:jjrfmx:v:17:y:2024:i:2:p:71-:d:1337388
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    References listed on IDEAS

    as
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