An overview of asset pricing models andreas krause university of bath school of management phone. An overview of asset pricing models university of bath. A major research initiative in finance focuses on the determinants of the crosssectional and time series properties of asset returns. Cochrane traces the pricing of all assets back to a single ideaprice equals expected discounted payoffthat.
This section contains free ebooks and guides on investments, some of the resources in this section can be viewed online and some of them can be downloaded. Undoubtedly, the capital asset pricing model capm developed by sharpe 1964, lintner 1965, and mossin 1966 is the best known asset pricing model. Asset pricing theory 12 1 consumptionbased model and overview 1. Financial decisions and markets princeton university press. Consumption based asset pricing models use marginal rates of substitution to determine the relative prices of the date, eventcontingent, composite consumption good. Pdf the consumptionbased capital asset pricing model. Housing, consumption, and asset pricing monika piazzesi, martin schneider, selale tuzel. This paper discusses the issues and controversies surrounding consumptionbased capital asset pricing models ccapms. Du e, dynamic asset pricing for continuous time methods. John jumps right in to data with the equity premium, riskfree rate, and volatility puzzles p.
This book advocates a discount factor generalized method of. Cochrane graduate school of business university of chicago 1101 e. The course then turns to the capital asset pricing model capm and consumptionbased asset pricing model, and develops dynamic portfolio choice problems and equilibrium asset pricing theories. Using the url or doi link below will ensure access to this page indefinitely. Consumptionbased asset pricing models use marginal rates of substitution to.
Theory the essential element in modern asset pricing theory is a positive random variable. With that objective in mind, asset pricing models have been developed, starting with the capital asset pricing models of sharpe 1964, lintner 1965, and mossin 1966. A brief introduction to the consumption based asset pricing model ccapm we have seen that capm identifies the risk of any security as the covariance between the securitys rate of return and the rate of return on the market portfolio. Take asset j as the riskfree asset, with return d a j r d t.
Explaining the poor performance of consumptionbased asset. Review article full text access chapter 12 tests of multifactor pricing models, volatility bounds and portfolio performance. A major failing of the consumptionbased capitalasset pricing model is that asset returns have little correlation with consumption growth. The consumption based capital asset pricing model ccapm is a model of the determination of expected i. Experimental test of the lucas asset pricing model the. This paper considers a consumption based asset pricing model where housing is explicitly modeled both as an asset and as a consumption good.
An asset pricing model aims to identify economic or statistical factors that eliminate model mispricing. Problem 1 consumption based capital asset pricing model. He introduces students to leading theories of portfolio choice, their implications for asset prices, and empirical patterns of risk and return in financial markets. From capm to market anomalies, credit risk implications for the cross section of asset returns, rational versus behavioural attributes of stylized crosssectional effects, conditional capm, conditional versus unconditional portfolio efficiency, multifactor models, interpreting factor models, machine. Samuelson award for scholarly writing on lifelong financial security, john cochranes asset pricing now appears in a revised model that unifies and brings the science of asset pricing up to date for superior school college students and professionals. Consumption based asset pricing model the consumption based capital asset pricing model ccapm presented below depends on a number of assumptions regarding the model structure.
Consumptionbased asset pricing models use marginal rates of substitution to determine the relative prices of the date, eventcontingent, composite consumption good. How can consumptionbased assetpricing models explain low. Free investments books download ebooks online textbooks. The capital asset pricing model is an elegant theory with profound implications for asset pricing and investor behavior. This is the well known capital asset pricing model capm, presently in a slightly unusual guise. Request pdf consumption based asset pricing models. In consumptionbased assetpricing models there are no liquidity constraints or other transaction costs, so agents can trade assets freely at each period. Asset pricing, economic fluctuations and growth, monetary economics. The model is a generalization of the capital asset pricing model capm.
Under general equilibrium, prices must constantly adjust to maintain the balance between supply and demand on. Consumptionbased capital asset pricing model wikipedia. In consumption based asset pricing models there are no liquidity constraints or other transaction costs, so agents can trade assets freely at each period. Background knowledge expected utility theory stochastic dynamic programming asset pricing asset pricing model lucas 1978 treat consumption and output as exogenous and asset prices as endogenous also called as the icapm intertemporal capital asset pricing model or consumptionbased capital asset pricing model.
The consumptionbased capital asset pricing model by darrell duffie and william zame1 the paper provides conditions on the primitives of a continuoustime economy under which there exist equilibria obeying the consumptionbased capital asset pricing model ccapm. Cochrane abstract we show that the external habitformation model economy of campbell and cochrane 1999. A brief introduction to the consumption based asset. Asset pricing available for download and read online in other formats. Topics in asset pricing hebrew university of jerusalem. Financial economics consumptionbased capm one could regard this low correlation as a problem for. First, we can examine whether real world asset prices and investor portfolios conform to the. The asset pricing field is vast, but we will focus primarily on two core ideas. The asset prices we discuss would include prices of bonds and stocks, interest rates, exchange rates, and derivatives of all these underlying. A survey of the literature 7 perspective of individual choices, where the market values i. Consumptionbased general equilibrium asset pricing, pioneered by stiglitz 1970, lucas 1978, and breeden 1979, remains a workhorse model in financial economics and macrofinance.
Explaining the poor performance of consumptionbased. Cochrane begins powerfully, introducing us to the notion that the consumption based asset pricing equation, given by an investors firstorder conditions, is the central formulation in asset pricing. In order to see the equivalence between this version of the capm and the traditional sharpe 1964lintner 1965 marketportfolio based. Data from other countries are examined to see which features of the us experience apply more generally. Jun 22, 2019 consumption capital asset pricing model ccapm. Download it once and read it on your kindle device, pc, phones or tablets. Consumption based asset pricing models, the discount factor representation in asset pricing, the equity premium puzzle, the risk free rate puzzle, the epsteinzin. Artem, 923 vayanos 1998, transaction costs and asset prices. The foundations of this concept were laid by the research of robert lucas 1978 and douglas breeden 1979 the model is a generalization of the capital asset pricing model capm.
A financial model that extends the concepts of the capital asset pricing model capm to include the amount that an individual or firm wishes to. Consumptionbased model and overview princeton university. While ccapms provide a chance to explain the phenomena observed in stock markets, their viability is jeopardized owing to the weak predictability of the equity premium and riskfree rate puzzles. Consumption capital asset pricing model ccapm definition. According to the capm, the uncertainty associated with the return on the market portfolio is the sole. The key message of the model is that the expected excess return on a risky. Topics and papers transactions costs and liquidity risk acharya and pedersen 2002, asset pricing with liquidity risk, working paper, new york university. Then he quickly outlines the huge literature of responses to the puzzles p. The course then turns to the capital asset pricing model capm and consumption based asset pricing model, and develops dynamic portfolio choice problems and equilibrium asset pricing theories. Capm the capm of sharpe 1964, lintner 1965, and mossin 1966 originates the literature on asset pricing models. This model class is characterized by a stochastic discount factor process that puts restrictions on the joint process of asset returns and per capita consumption. Consumption and asset pricing yinchi wangs webpage.
I will hand out a free hardcopy of the manuscript to all students registered in the course. How can consumptionbased assetpricing models explain. Asset pricing, economic fluctuations and growth, monetary economics this paper considers a consumptionbased asset pricing model where housing is explicitly modeled both as an asset and as a consumption good. The consumptionbased capital asset pricing model article pdf available in econometrica 576. The capm model deals with the question of how asset prices and yields are determined, under the hypothesis that the riskfree interest rate and market return are variables determined outside the model. Optimal dynamic trading with informational advantage 7. On the robustness of consumptionbased asset pricing theory. The consumptionbased capital asset pricing model ccapm is a model of the determination of expected i. Campbell, lo, mackinlay, the econometrics of financial markets for empirical topics. Cochrane, asset pricing, princeton university press, revised ed. The paper also extends the equilibrium characterization of interest rates of cox.
The recent theoretical literature is used to guide the exploration of the international data. We will now use the euler equation to derive an asset pricing equation. An investors firstorder conditions give the basic consumption based. Consumptionbased asset pricing 2 1 overview from macroeconomics, here are the equations that describe the aggregate production function. This approach relates asset prices to risk and time preferences, dividend payments, and other fundamental determinants of asset values. The chapter lists some important stylized facts that characterize us data, and relates them to recent developments in equilibrium asset pricing theory. Chapter 6 on consumption based asset pricing is likewise elegant and comprehensive. Capm, icapm, apt, option pricing, and finally consumptionbased model.
The capm is an equilibrium model in a singleperiod economy. Consumptionbased asset pricing models arizona state. A brief introduction to the consumption based asset pricing. Samuelson award for scholarly writing on lifelong financial security, john cochranes asset pricing now appears in a revised edition that unifies and brings the science of asset pricing up to date for advanced students and professionals. Each model consumption based, capm, multifactor, term structure, and option pricing is derived as a different specification of the discounted factor. The foundations of this concept were laid by the research of robert lucas 1978 and douglas breeden 1979. Chapter 12 advances in consumptionbased asset pricing. Consumption based asset pricing 2 1 overview from macroeconomics, here are the equations that describe the aggregate production function. Financial economics consumptionbased capm consumptionbased capm as equation 2 holds for any asset i, we could subtract the equation for one asset from the equation for another asset to ge t 0 e 1. Introduction to asset pricing theory the theory of asset pricing is concerned with explaining and determining prices of. An introduction to investment theory download book. Consumptionbased asset pricing models arizona state university. Cochrane begins powerfully, introducing us to the notion that the consumptionbased asset pricing equation, given by an investors firstorder conditions, is the central formulation in asset pricing.
No part of this book may be distributed, posted, or. Consumptionbased asset pricing models academic web pages. Pastor and stambaugh 2002, liquidity risk and expected stock returns, working paper, chicago and wharton. Back, asset pricing and portfolio choice theory as a backup reference for the cochrane book with slightly more technical details. Consumptionbased asset pricing models imply that, although expected returns can vary across time and. He presents applications to stocks, bonds, and options.
The discount factor framework also leads to a statespace geometry for meanvariance frontiers and asset pricing models. But how useful is the model given the idealized world that underlies its derivation. Most previous dynamic asset pricing experiments depart in significant ways from consumption based models. This paper examines asset pricing models using not seasonally adjusted aggregate consumption data. Most importantly, risk corrections to asset prices should be driven by the covariance of asset. Topics in asset pricing lecture notes professor doron avramov. Theory the essential element in modern asset pricing theory is a positive random variable called the stochastic discount factor sdf. From capm to market anomalies, credit risk implications for the cross section of asset returns, rational versus behavioural attributes of stylized crosssectional effects, conditional capm, conditional versus unconditional portfolio efficiency, multifactor models, interpreting factor models, machine learning methods.
Notes and references 175 part two dynamic models 8. He and modest 1995, market frictions and consumptionbased asst pricing, journal of political economy 103, 94117. Asset pricing and portfolio choice theory second edition. Stanford libraries official online search tool for books, media.
623 1066 1307 382 47 1239 1340 230 1069 806 622 1453 616 1415 630 762 429 15 1196 1303 813 1027 1435 475 313 504 260 761 1040 17 44 569 1102 293 1203 1028 299 231 1113 359 453 86 976 1018 1429