From Which Consumption-Based Asset Pricing Models Can Investors Profit? Evidence from Model-Based Priors

40 Pages Posted: 11 Feb 2014 Last revised: 28 Oct 2020

See all articles by Mathias S. Kruttli

Mathias S. Kruttli

Kelley Business School - Indiana University

Date Written: July 15, 2020

Abstract

This paper analyzes whether consumption-based asset pricing models improve the equity premium forecasts of a hypothetical investor with access to these models from 1947 onwards. The investor imposes economic constraints derived from asset pricing models as model-based priors on predictive regression parameters through a Bayesian framework. Three models are considered: Habit Formation, Long-Run Risk, and Prospect Theory. The model-based priors generally perform better than priors that shrink the parameter estimates to the historical average model and priors that impose a positive equity premium. This analysis helps to assess the value of consumption-based asset pricing models to investors.

Keywords: Return predictability, consumption-based asset pricing, Bayesian econometrics

JEL Classification: G11, G12, G17

Suggested Citation

Kruttli, Mathias S., From Which Consumption-Based Asset Pricing Models Can Investors Profit? Evidence from Model-Based Priors (July 15, 2020). Available at SSRN: https://ssrn.com/abstract=2393532 or http://dx.doi.org/10.2139/ssrn.2393532

Mathias S. Kruttli (Contact Author)

Kelley Business School - Indiana University ( email )

Bloomington, IN 47405
United States

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