An Extension of the Consumption-Based CAPM Model

42 Pages Posted: 8 Mar 2012 Last revised: 1 Oct 2012

See all articles by Georges Dionne

Georges Dionne

HEC Montreal - Department of Finance

Jingyuan Li

Lingnan University - Department of Finance and Insurance

Cedric Okou

University of Quebec at Montreal (UQAM)

Date Written: May 8, 2012

Abstract

We extend the Consumption-based CAPM (C-CAPM) model to representative agents with different risk attitudes. We first use the concept of expectation dependence and show that for a risk averse representative agent, it is the first-degree expectation dependence (FED) rather than the covariance that determines C-CAPM's riskiness. We extend the assumption of risk aversion to prudence and propose the measure of second-degree expectation dependence (SED) to obtain the values of asset price and equity premium. These theoretical results are linked to the equity premium puzzle. Using the same dataset as in Campbell (2003), the estimated measures of relative risk aversion from FED and SED approximations are much lower than those obtained in the original study and correspond to the theoretical values often discussed in the literature. The theoretical model is then generalized to higher-degree risk changes and higher-order risk averse representative agents.

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 and Okou, Cedric, An Extension of the Consumption-Based CAPM Model (May 8, 2012). Available at SSRN: https://ssrn.com/abstract=2018476 or http://dx.doi.org/10.2139/ssrn.2018476

Georges Dionne (Contact Author)

HEC Montreal - Department of Finance ( email )

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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

Cedric Okou

University of Quebec at Montreal (UQAM) ( email )

PB 8888 Station DownTown
Succursale Centre Ville
Montreal, Quebec H3C3P8
Canada
514-987-3000 Ext. 5521 (Phone)

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