| A number of recent papers have developed multifactor extensions of the classic consumption capital asset pricing model (CCAPM), and found that they perform remarkably well in explaining the cross-section of stock returns. While the extant literature has generally concluded that conditioning information improves the empirical performance of the CCAPM, the empirical work to date has primarily employed cross-sectional regressions that ignore theoretical restrictions on the time-series intercepts in regressions of each test asset return on the model's factors.The first chapter asks whether the superior empirical performance of the multifactor CCAPMs is maintained once the time-series intercept restrictions have been explicitly tested. The use of maximum correlation portfolios makes it straightforward to test whether such multifactor CCAPMs satisfy the time-series intercept restrictions, since in this case the single testable implication of the model is that each intercept should be zero. It is suggested that base assets used to form the maximum correlation portfolio be chosen to span a set of test assets of which cross-sectional variation will be tested. The empirical findings support the conclusion that multifactor CCAPMs can explain the cross-section of expected stock returns better than classic unconditional models such as the CAPM and CCAPM. Moreover, some of the multifactor CCAPMs are shown to perform as well as or better than the Fama and French (1993) three-factor model.The second chapter applies the intercept restrictions to the cross-sectional performances of candidate consumption-based models using conditional moments. I use two different ways to evaluate the performance of consumption-based asset pricing models to explain the cross-section of expected stock returns using conditional moments: one is to apply scaled returns, and the other is to model time-varying factor loadings, using instrument variables. A maximum correlation portfolio is constructed to directly impose a restriction on the time-series intercept, especially in a model whose factors are not returns. Based on both types of tests, consumption-based models show no better performance than the standard CAPM adding a return on human capital as an additional risk factor does not help explain the cross-section and the Fama-French three-factor model shows the best ability to lower the pricing error. |
