TY  - JOUR
AU  - Campbell,John Y.
AU  - Cochrane,John H.
TI  - Explaining the Poor Performance of Consumption-Based Asset Pricing Models
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7237
PY  - 1999
Y2  - July 1999
UR  - http://www.nber.org/papers/w7237
L1  - http://www.nber.org/papers/w7237.pdf
N1  - Author contact info:
John Y. Campbell
Morton L. and Carole S.
Olshan Professor of Economics
Department of Economics
Harvard University
Littauer Center 213
Cambridge, MA 02138
Tel: 617/496-6448
Fax: 617/495-7730
E-Mail: john_campbell@harvard.edu

John H. Cochrane
Booth School of Business
University of Chicago
5807 S. Woodlawn
Chicago, IL  60637
Tel: 773/702-3059
Fax: 773/702-0458
E-Mail: john.cochrane@chicagobooth.edu
AB  - The poor performance of consumption-based asset pricing models relative to traditional portfolio-based asset pricing models is one of the great disappointments of the empirical asset pricing literature.  We show that the external habit-formation model economy of Campbell and Cochrane (1999) can explain this puzzle. Though artificial data from that economy conform to a consumption-based model by construction, the CAPM and its extensions are much better approximate models than is the standard power utility specification of the consumption-based model.  Conditioning information is the central reason for this result.  The model economy has one shock, so when returns are measured at sufficiently high frequency the consumption-based model and the CAPM are equivalent and perfect conditional asset pricing models.  However, the model economy also produces time-varying expected returns, tracked by the dividend-price ratio. Portfolio-based models capture some of this variation in state variables, which a state-independent function of consumption cannot capture, and so portfolio-based models are better approximate unconditional asset pricing models.
ER  -