A Theoretical Extension of the Consumption-Based CAPM Model

Abstract:     
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

working papers series