Merton 's (1973) intertemporal capital asset pricing model (ICAPM) was developed to capture this multi-period aspect of financial market equilibrium. We still don 't know exactly how many factors there are, but the ICAPM at least gives us some guidance.
Consumption-Oriented Capital Asset Pricing Model The consumption-based model of Breeden (1979) provides a logical extension of the previous work in asset pricing. Based on this "diminishing marginal utility of consumption," securities that have high returns when aggregate consumption is low will be demanded by investors, bidding up their prices (and lowering their expected returns). In contrast, stocks that co-vary positively with aggregate consumption will require higher expected returns, since they provide high returns during states of the economy where the high returns do the least good.
Based on this line of reasoning, Breeden derives a consumption-based capital asset pricing model (CCAPM) of the form:
CCAPM E(Rj) = Rf + ßjC [E(Rm) - …show more content…
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