Do Consumption-Based Asset Pricing Models Explain Own-History Predictability in Stock Market Returns?

44 Pages Posted: 18 May 2018 Last revised: 28 Aug 2020

See all articles by Michael Ashby

Michael Ashby

Faculty of Economics, University of Cambridge; Downing College, Cambridge

Oliver B. Linton

University of Cambridge

Date Written: August 18, 2020

Abstract

We show that three prominent consumption-based asset pricing models - the Bansal-Yaron, Campbell-Cochrane and Cecchetti-Lam-Mark models - cannot explain the own-history predictability properties of stock market returns. We show this by estimating these models with GMM, deriving ex-ante expected returns from them and then testing whether the difference between realised and expected returns is a martingale difference sequence, which it is not. Furthermore, a semi-parametric test suggests that lagged returns have too much predictive power over current returns to be consistent with the state variables which explain market returns being the same as the state variables which explain market returns in any of the three models.

Keywords: Consumption-Based Asset Pricing Models, Serial Correlation, Predictability, Martingale Difference Sequence, Variance Ratio, Quantilogram, Rescaled Range, Mean Reversion

JEL Classification: C52, C58, G12

Suggested Citation

Ashby, Michael and Linton, Oliver B., Do Consumption-Based Asset Pricing Models Explain Own-History Predictability in Stock Market Returns? (August 18, 2020). Available at SSRN: https://ssrn.com/abstract=3173586 or http://dx.doi.org/10.2139/ssrn.3173586

Michael Ashby (Contact Author)

Faculty of Economics, University of Cambridge ( email )

Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Downing College, Cambridge ( email )

Regent St
Cambridge, CB2 1DQ
United Kingdom

Oliver B. Linton

University of Cambridge ( email )

Faculty of Economics
Cambridge, CB3 9DD
United Kingdom

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