SIFR Research Report Series,
Institute for Financial Research

Abstract: This paper studies if the consumption-based asset pricing model can explain the cross-section of Sharpe ratios. The CRRA model and several extensions (habit persistence, recursive utility and idiosyncratic shocks) all imply that the Sharpe ratio is linearly increasing in the asset's correlation with aggregate consumption growth. Results from quarterly data on 40 US portfolios (1947-2001) and 10 international portfolios (1957/1971-2001) suggest that both the unconditional and conditional C-CAPM have serious problems: there is a great deal of variation in Sharpe ratios, but most portfolios have relatively similar and low correlations with aggregate consumption growth.

Keywords: Cosumption-based asset pricing; habit persistence; recursive utility; idiosyncratic risk; multivariate GARCH

JEL-codes: G12

17 pages, August 15, 2003

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