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A Theoretical Extension of the Consumption-Based CAPM Model

27 Pages Posted: 13 Dec 2010 Last revised: 2 Jun 2011

Georges Dionne

HEC Montreal - Department of Finance

Jingyuan Li

Lingnan University - Department of Finance and Insurance

Date Written: May 31, 2011

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.

Keywords: Consumption-Based CAPM, Risk Premium, Equity Premium Puzzle, Expectation Dependence, Ross risk aversion

JEL Classification: D51, D80, G12

Suggested Citation

Dionne, Georges and Li, Jingyuan, A Theoretical Extension of the Consumption-Based CAPM Model (May 31, 2011). Available at SSRN: https://ssrn.com/abstract=1724699 or http://dx.doi.org/10.2139/ssrn.1724699

Georges Dionne (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-6596 (Phone)
514-340-5019 (Fax)

HOME PAGE: http://www.hec.ca/gestiondesrisques/

Jingyuan Li

Lingnan University - Department of Finance and Insurance ( email )

Castle Peak Road
Tuen Mun, New Territories
Hong Kong
China

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