A Single-Factor Consumption-Based Asset Pricing Model
97 Pages Posted: 5 Jun 2016 Last revised: 7 Dec 2017
Date Written: December 6, 2017
We propose a single-factor asset pricing model based on an indicator function of consumption growth being less than its endogenous certainty equivalent. This certainty equivalent is derived from generalized disappointment aversion preferences, and it is located approximately one standard deviation below the conditional mean of consumption growth. Our single-factor model can explain the cross-section of expected returns for size, value, reversal, profitability, and investment portfolios at least as well as the Fama-French multi-factor models. Our results show strong empirical support for asymmetric preferences, and question the effectiveness of the smooth utility framework, which is traditionally used in consumption-based asset pricing.
Keywords: asset pricing, stock returns, consumption, disappointment aversion, indicator, certainty equivalent, risk aversion
JEL Classification: D51, D91, E21, G12
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