A Theoretical Extension of the Consumption-Based CAPM Model
HEC Montreal - Department of Finance
Lingnan University - Department of Finance and Insurance
May 31, 2011
We extend the Consumption-based CAPM (C-CAPM) model to representative agents with different risk attitudes. We use the concept of expectation dependence and show that for a risk averse representative agent, it is the first-degree expectation dependence rather than the covariance that determines C-CAPM's riskiness. We extend the assumption of risk aversion to prudence and provide an additional dependence condition to obtain the values of asset price and equity premium. Results are generalized to higher-degree risk changes and higher- order risk averse representative agents, and are linked to the equity premium puzzle.
Number of Pages in PDF File: 27
Keywords: Consumption-Based CAPM, Risk Premium, Equity Premium Puzzle, Expectation Dependence, Ross risk aversion
JEL Classification: D51, D80, G12
Date posted: December 13, 2010 ; Last revised: June 2, 2011
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