Ashby, M., Linton, O. B.
Do consumption-based asset pricing models explain the dynamics of stock market returns?
CWPE2259
Abstract: We show that three prominent consumption-based asset pricing models - the Bansal-Yaron, Campbell-Cochrane and Cecchetti-Lam-Mark models - cannot explain the dynamic 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. Mincer-Zarnowitz regressions show that the models’ out-of-sample expected returns are systematically biased. Furthermore, semi-parametric tests of whether the models’ state variables are consistent with the degree of own-history predictability in stock returns suggest that only the Campbell-Cochrane habit variable may be able to explain return predictability, although the evidence on this is mixed.
Keywords: consumption-based asset pricing models, martingale difference sequence, MIDAS, power spectrum, predictability, quantilogram, rescaled range, serial correlation, variance ratio
JEL Codes: C52 C58 G12
Author links: Oliver Linton Michael Ashby
PDF: https://www.econ.cam.ac.uk/research-files/repec/cam/pdf/cwpe2259.pdf 
Open Access Link: https://doi.org/10.17863/CAM.91995
