From Which Consumption-Based Asset Pricing Models Can Investors Profit? Evidence from Model-Based Priors

• Main Author: Kruttli, M.S (Author)
• Format: Article
• Language: English
• Published: Oxford University Press 2022
• Subjects: Bayesian econometrics; consumption-based asset pricing; G11; G12; G17; return predictability
• Online Access: View Fulltext in Publisher

 This article analyzes whether consumption-based asset pricing models improve the excess returns forecasts of a hypothetical investor with access to these models from 1947 onwards. The investor imposes economic constraints derived from asset pricing models as model-based priors on predictive regression parameters through a Bayesian framework. Three models are considered: habit formation, long-run risk, and prospect theory. The model-based priors generally perform better than priors that shrink the parameter estimates to the historical average model and priors that impose a positive equity premium. This analysis helps to assess the value of consumption-based asset pricing models to investors. © 2020 Published by Oxford University Press 2020. This work is written by a US Government employee and is in the public domain in the US.