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Faculty of Economics

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Ashby, M., Linton, O. B.

Do Consumption-based Asset Pricing Models Explain Own-history Predictability in 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 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, 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  

PDF: https://www.econ.cam.ac.uk/research-files/repec/cam/pdf/cwpe2259.pdf