Resurrecting the (C)CAPM: A Cross‐Sectional Test When Risk Premia Are Time‐Varying

This paper explores the ability ofconditionalversions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditiona...

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Bibliographic Details
Published in:The Journal of political economy 2001-12, Vol.109 (6), p.1238-1287
Main Authors: Lettau, Martin, Ludvigson, Sydney
Format: Article
Language:English
Subjects:
Arithmetic mean
Asset valuation
Capital asset pricing models
Capital assets
Capital market
Consumption
Economic theory
Financial portfolios
Growth stocks
Human capital
Mathematical models
Parametric models
Political economy
Portfolio performance
Price theory
Risk
Risk aversion
Scale modeling
Stock
Stock prices
Stock returns
Studies
Wealth
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Summary:This paper explores the ability ofconditionalversions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditional models perform far better than unconditional specifications and about as well as the Fama‐French three‐factor model on portfolios sorted by size and book‐to‐market characteristics. The conditional consumption CAPM can account for the difference in returns between low‐book‐to‐market and high‐book‐to‐market portfolios and exhibits little evidence of residual size or book‐to‐market effects.
ISSN:0022-3808
1537-534X
DOI:10.1086/323282