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Resurrecting the (C)CAPM: A CrossSectional Test When Risk Premia Are TimeVarying
 Journal of Political Economy
, 2001
"... This paper explores the ability of conditional versions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditio ..."
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Cited by 139 (5 self)
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This paper explores the ability of conditional versions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditional models perform far better than unconditional specifications and about as well as the FamaFrench threefactor model on portfolios sorted by size and booktomarket characteristics. The conditional consumption CAPM can account for the difference in returns between lowbooktomarket and highbooktomarket portfolios and exhibits little evidence of residual size or booktomarket effects. We are grateful to Eugene Fama and Kenneth French for graciously providing the
Housing collateral, consumption insurance, and risk premia, Working paper
, 2002
"... In a model with housing collateral, the ratio of housing wealth to human wealth shifts the conditional distribution of asset prices and consumption growth. A decrease in house prices reduces the collateral value of housing, increases household exposure to idiosyncratic risk, and increases the condit ..."
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Cited by 58 (2 self)
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In a model with housing collateral, the ratio of housing wealth to human wealth shifts the conditional distribution of asset prices and consumption growth. A decrease in house prices reduces the collateral value of housing, increases household exposure to idiosyncratic risk, and increases the conditional market price of risk. Using aggregate data for the US, we find that a decrease in the ratio of housing wealth to human wealth predicts higher returns on stocks. Conditional on this ratio, the covariance of returns with aggregate risk factors explains eighty percent of the crosssectional variation in annual size and booktomarket portfolio returns. 1
Equilibrium Cross Section of Returns
"... We construct a dynamic general equilibrium production economy to explicitly link expected stock returns to firm characteristics such as firm size and the booktomarket ratio. Stock returns in the model are completely characterized by a conditional capital asset pricing model (CAPM). Size and bookt ..."
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Cited by 50 (11 self)
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We construct a dynamic general equilibrium production economy to explicitly link expected stock returns to firm characteristics such as firm size and the booktomarket ratio. Stock returns in the model are completely characterized by a conditional capital asset pricing model (CAPM). Size and booktomarket are correlated with the true conditional market beta and therefore appear to predict stock returns. The crosssectional relations between firm characteristics and returns can subsist even after one controls for typical empirical estimates of beta. These findings suggest that the empirical success of size and booktomarket can be consistent with a singlefactor conditional CAPM model. We gratefully acknowledge the helpful comments of Andy Abel, Jonathan Berk, Michael
Fundamental determinants of national equity market returns: A perspective on conditional asset pricing
, 1998
"... ..."
Habit Formation and the Cross Section of Stock Returns
, 2002
"... We develop an external habit persistence model where the time series of the aggregate portfolio and the cross section of stock returns are simultaneously studied and tested. By applying a slightly modified version of the model of Campbell and Cochrane (1999), we obtain closed form solutions for indi ..."
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Cited by 23 (3 self)
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We develop an external habit persistence model where the time series of the aggregate portfolio and the cross section of stock returns are simultaneously studied and tested. By applying a slightly modified version of the model of Campbell and Cochrane (1999), we obtain closed form solutions for individual securities prices and returns and a full characterizations of the dynamics of the riskreturn characteristics of individual securities. We find that each stock return “beta” with respect to the total wealth portfolios is jointly determined by an aggregate variable that depends on the habit level, and an idiosyncratic asset characteristics that depends on the contribution of the security to total consumption relative to its longrun average contribution. This functional form imposes tight predictions on the cross sectional test, including sign and magnitude of the coefficients, and insures that the explanatory power of the beta comes from the predictable part of the realization of returns. An estimate of the model for a set of 20 industry portfolios is able to explain crosssectional variation in the conditional expected returns. Moreover, the model generates price consumption ratios for individual industries that track well the empirical ones.
Asset Pricing with Conditioning Information: A New Test
, 1999
"... This paper develops a new approach to testing dynamic linear factor models, which aims at timevariation in Jensen's alphas while using a nonparametric pricing kernel to incorporate conditioning information. In application we find that the conditional CAPM performs substantially better than the stat ..."
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Cited by 21 (2 self)
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This paper develops a new approach to testing dynamic linear factor models, which aims at timevariation in Jensen's alphas while using a nonparametric pricing kernel to incorporate conditioning information. In application we find that the conditional CAPM performs substantially better than the static CAPM, but still it is statistically rejected. The conditional CAPM exhibits timevarying Jensen's alphas that have a strong size pattern in volatility and a clear booktomarket pattern in timeseries average. These features are well captured by a simple dynamic version of the Fama and French (1993) three factor model. Moreover, even with portfolios formed on past returns we can not reject this model. Recent research has documented evidence of timevariation in expected returns, return volatilities, and betas of nancial assets. Meanwhile, researchers have identified a number of anomalies against the unconditional version of the Capital Asset Pricing Model (CAPM) of Sharpe (1964) and Lintn...
Tests of the Relations Among Marketwide Factors, Firmspecific Variables, and Stock Returns Using a Conditional Asset Pricing Model
 Journal of Finance
, 1996
"... In this paper we generalize Harvey's (1989) empirical specification of conditional asset pricing models to allow for both timevarying covariances between stock returns and marketwide factors and timevarying rewardtocovariabilities. The model is then applied to examine the e#ects of firm size an ..."
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Cited by 11 (2 self)
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In this paper we generalize Harvey's (1989) empirical specification of conditional asset pricing models to allow for both timevarying covariances between stock returns and marketwide factors and timevarying rewardtocovariabilities. The model is then applied to examine the e#ects of firm size and booktomarket equity ratios. We find that the traditional asset pricing model with commonly used factors can only explain a small portion of the stock returns predicted by firm size and booktomarket equity ratios. The results indicate that allowing timevarying covariances and timevarying rewardtocovariabilities does little to salvage the traditional asset pricing models.
Conditional Risk and Performance Evaluation: Volatility Timing, Overconditioning, and New Estimates of Momentum Alphas
, 2009
"... Unconditional alpha estimates are biased when conditional beta covaries with market risk premia (“markettiming”) or volatility (“volatilitytiming”). We demonstrate an additional bias (“overconditioning”) that can occur any time an empiricist uses a risk proxy not in the investor information set — ..."
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Cited by 8 (1 self)
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Unconditional alpha estimates are biased when conditional beta covaries with market risk premia (“markettiming”) or volatility (“volatilitytiming”). We demonstrate an additional bias (“overconditioning”) that can occur any time an empiricist uses a risk proxy not in the investor information set — for example when asset payoffs are nonlinear and the conditional loading is proxied by contemporaneous realized beta. Calibrating to U.S. equity returns, volatilitytiming and overconditioning plausibly impact alphas much more than markettiming, which has been the focus of prior literature. A variety of instrumental variables estimators using realized betas can substantially correct market and volatilitytiming biases, while eliminating overconditioning. Empirically, appropriate instrumentation reduces momentum alphas by 2040 % relative to unconditional, whereas overconditioned alphas overstate performance by up to 2.5 times. Volatilitytiming inflates unconditionally estimated momentum alpha because the formationperiod market return (i) positively predicts holdingperiod beta (Grundy and Martin, 2001) and (ii) negatively predicts holdingperiod market volatility (French, Schwert, and Stambaugh,
income risk and asset returns
"... This paper shows, from the consumer’s budget constraint, that expected future labor income growth rates and the residuals of the cointegration relation among log consumption, log asset wealth and log current labor income (summarized by the variable cay of Lettau and Ludvigson (2001a)), should help p ..."
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Cited by 4 (0 self)
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This paper shows, from the consumer’s budget constraint, that expected future labor income growth rates and the residuals of the cointegration relation among log consumption, log asset wealth and log current labor income (summarized by the variable cay of Lettau and Ludvigson (2001a)), should help predict U.S. quarterly stock market returns and explain the crosssection of average returns. I find that a) fluctuations in expected future labor income are a strong predictor of both real stock returns and excess returns over a Treasury bill rate, b) when this variable is used as conditioning information for the Consumption Capital Asset Pricing Model (CCAPM), the resulting linear factor model explains four fifth of the variation in observed average returns across the Fama and French (25) portfolios and prices correctly the small growth portfolio. The paper also finds that about one third of the variance of returns is predictable, over a horizon of one year, using expected future labor income growth rates and cay jointly as forecasting variables.