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

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jats:pWe 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.</jats:p>


Peer reviewed: True

Acknowledgements: We thank Tiago Cavalcanti, Sonje Reiche, Melvyn Weeks and especially Mark Salmon, Donald Robertson and Gregory Connor for helpful comments and feedback which greatly improved this paper, as well as participants at the Cambridge Econometrics Workshop. We are also very grateful to Yongmiao Hong and Yoon-Jin Lee for sharing the GAUSS code for implementing their generalised spectral test. Wharton Research Data Services (WRDS) was used in preparing this article. This service and the data available thereon constitute valuable intellectual property and trade secrets of WRDS and/or its third-party suppliers.

Publication status: Published

Funder: Tudor Studentship in Financial Econometrics


38 Economics, 3502 Banking, Finance and Investment, 3801 Applied Economics, 35 Commerce, Management, Tourism and Services

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Journal of Risk and Financial Management

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ESRC (1515004)
Tudor Studentship in Financial Econometrics