This model generalizes the marketreturn decomposition framework, showing that intertemporal considerations imply a decomposition of squared market returns coskewness risk. An intertemporal asset pricing model with stochastic consumption and investment opportunities douglas t. Mertons 1973 intertemporal capital asset pricing model icapm shows that such assets should deliver lower average returns in equilibrium if they are priced from conservative longterm investorsrstorder conditions. Estimation and estt of a simple model of intertemporal.
In finance, the capital asset pricing model capm is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a welldiversified portfolio. It extends the analysis in mertons earlier consumption and portfolio rules papertoconsider theequilibrium relations between assetrates. The investment approach changes the big picture of asset pricing. Section iii contains a description of the data used in our empirical implementation of the model, as well as an outline of the construc. An intertemporal capital asset pricing model with owner. Risk is measured using a fourfactor model motivated by the intertemporal capital asset pricing model. We then explore the implications of this model on the joint behavior of vol ume and returns. Risk aversion and intertemporal substitution in tile capital asset pricing model alberto ciovannini philippe weil working paper no. An intertemporal capital asset pricing model article pdf available in econometrica 415. A threemoment intertemporal capital asset pricing model. Intertemporal capital asset pricing model without state.
Intertemporal capital asset pricing and the famafrench threefactor model. Intertemporal capital asset pricing and the famafrench. Estimation and estt of a simple model of intertemporal capital asset pricing. Asset pricing i slide 118 static problem intertemporal problem in general icapm setting crra with 1 and changing investment opportunity sets special cases 1. In section ii, we explore the models implications for volume and returns. Ross 1985 an intertemporal general equilibrium model of asset prices, econometrica 53, p. In section i, we present our intertemporal equilibrium model of asset pricing and trading volume. Assumptions these notes are based on the article robert c. The meanreverting dcc model is used to estimate a stocks portfolios conditional covariance with the market and test whether the conditional covariance predicts timevariation in the stocks portfolios expected return. The capm model deals with the question of how asset prices and yields are determined, under the hypothesis that the riskfree interest rate and market return are variables determined outside the model. Intertemporal equilibrium pricingmarch 12, 2020 6 48 the consumption capital asset pricing model again. According to merton 1973 s intertemporal capital asset pricing model icapm, investors require higher compensation for holding stocks.
View citations in econpapers 1556 track citations by rss feed. Icapm first introduced by merton in 1973, is an extension of capm that additionally accounts for timevarying factors. This paper explores whether risk as measured by an alternative benchmark pricing model can explain the accrual anomaly. A model of intertemporal asset prices under asymmetric information jiang wang massachusetts institute of technology first version received february 1991, jnal version accepted september 1992 eds. Theory and evidence abstract in this paper, the aggregate consumption function is characterized as a nonlinear function of the market and hedge factors to derive a threemoment intertemporal capital asset pricing model that. Econophysics and capital asset pricing springerlink.
Robert mertons intertemporal capital asset pricing model fills this theoretical gap. We derive an intertemporal capital asset pricing model with multiple assets and heterogeneous investors, and explore its implications for the behavior of trading volume and asset returns. An intertemporal capital asset pricing model robert c. Risk aversion and intertemporal substitution in the capital. This paper presents a dynamic assetpricing model under asymmetric information. Since the seminal work of merton 1973 on the intertemporal capital asset pricing model icapm, a large empirical literature has explored the relevance of intertemporal considerations for the pricing of nancial assets in general, and the crosssectional pricing of stocks in particular. It states that, besides the market risk, risk of unfavorable shifts in the investment opportunity set proxied by. The icapm generalizes the singlefactor capm and explains why that model might fail to properly account for observed market excess returns. Think of the complete set of accounting standards of the fasb and the iasb as a product. Coskewness risk decomposition, covariation risk, and. The intertemporal capital asset pricing model icapm is a consumptionbased asset pricing model that provides the expected return on a security. There are a sufficient number of investors with comparable wealth levels so that each investor believes that he can buy and sell as much of an asset as he wants at the market price.
An intertemporal capital asset pricing model jstor. This paper builds on these insights by constructing a real options, termstructure model. We show that investors trade in only two portfolios. Intertemporal capital asset pricing and the famafrench threefactor model july 31, 2001. A financial model that extends the concepts of the capital asset pricing model capm to include the amount that an individual or firm wishes to.
Forestryrelated assets, especially timberland assets are regarded as good candidates for portfolio diversification because of its low correlation with market. Pdf intertemporal capital asset pricing and the famafrench. An investigation of commodity futures prices using the. Brennan, michael john and wang, ashley and xia, yihong, intertemporal capital asset pricing and the famafrench threefactor model july 31. While merton obtains the nice analytical result of a multifactor pricing model, it is not obvious what exactly the second factor. Yihong xia is an assistant professor at the wharton school of university of pennsylvania. Let al be the q x 1 vector of individual ks budget shares, i. An investigation of commodity futures prices using the consumption. We start with a description of the foundations laid by markowitz 1952 and a widelycited application, the capital asset pricing model. This paper extends the intertemporal capital asset pricing model icapm to integrate the heterogeneous trading behavior of three groups of investors. Lo and jiang wangy october 5, 2001 abstract we derive an intertemporal capital asset pric. Theory and evidence abstract in this paper, the aggregate consumption function is characterized as a nonlinear function of the market and hedge factors to derive a threemoment intertemporal capital asset pricing model that prices coskewness. In section ii, we explore the model s implications for volume and returns. Michael brennan is the goldyne and irwin hearsh professor of banking and finance at ucla, and professor of finance at london business school.
We derive an intertemporal asset pricing model and explore its implications for trading volume and asset returns. A model of intertemporal asset prices under asymmetric. If a real riskless asset or portfolio is assumed to exist and have a real return of r, then the expected return on a zero real consumptionbeta portfolio in the pricing eq. Jan 11, 2007 we derive an intertemporal asset pricing model and explore its implications for trading volume and asset returns. This paper is related to three broad streams of literature. Tests of the model suggest that a considerable portion of the crosssectional variation in average returns to high and low accrual firms is explained by risk. Merton 1973 an intertemporal capital asset pricing model, econometrica 41, p. The intertemporal capital asset pricing model, or icapm, is an alternative to the capm provided by robert merton. Breeden stanford university, stanford, ca 94305, usa received october 1978, revised version received july 1979 this paper derives a singlebeta asset pricing model in a multigood, continuoustime model. My bayesian framework accounts for uncertainty in the intertemporal risk factor and gauges the effects of prior information about investment opportunities on model inferences. Implications of an intertemporal capital asset pricing model created date. In a homoskedastic lognormal setting, the consumptionwealth ratio is shown to depend on the elasticity of intertemporal substitution in consumption, while asset risk premia are determined by. A financial model that extends the concepts of the capital asset pricing model capm to include. Implications of an intertemporal capital asset pricing model.
We begin by developing an intertemporal capital asset pricing model of multi ple assets in the spirit of mertons icapm merton, 1973. So, it turns out that the model s implications hold in more general contexts. Intertemporal capital asset pricing model icapm definition. Whereas capm uses market movement to predict a stocks return, ccapms explain the markets movement or a securitys movement by its relationship to aggregate consumption. An intertemporal capital asset pricing model with owneroccupied housing yongqiang chu school of business university of wisconsin email. In equilibrium, a twofactor linear pricing model holds, where the two factors are the returns on the market portfolio and the hedging portfolio, respectively. Kalev, konark saxena, and leon zolotoy abstract we develop an intertemporal asset pricing model where cash. The intertemporal capital asset pricing model with. Intertemporal asset pricing without consumption data. This paper modies mertons icapm by introducing owneroccupied housing.
Jun 22, 2019 consumption capital asset pricing model ccapm. Think of the residual income model as a valuation product, the altman zscore for bankruptcy prediction as a financial statement analysis product, and fair value accounting as a financial reporting product. Intertemporal capital asset pricing and the famafrench three. Estimation of the marginal rate of substitution in the. The authors are grateful to john cochrane for comments on a previous draft. Risk aversion and intertemporal substitution in the capital asset pricing model article pdf available february 1989 with 71 reads how we measure reads.
The intertemporal capital asset pricing model with dynamic. This paper proposes a riskbased explanation for the accrual anomaly. This model generalizes the marketreturn decomposition framework, showing that intertemporal considerations. The intertemporal capital asset pricing model of merton 1973 is examined using the dynamic conditional correlation dcc model of engle 2002. Building on the same premise, daniel and titman 1997 argue that the evidence that characteristics dominate covariances in horse races means mispricing. In section i, we present our intertemporal equilibrium model of assetpricing and trading volume. An intertemporal asset pricing model with stochastic. In this paper, the intertemporal capital asset pricing model icapm is used to assess the riskreturn relationship between forestry. Evidence from tests of an intertemporal capital asset pricing model mozaffar khan massachusetts institute of technology abstract this paper proposes a riskbased explanation for the accrual anomaly. According to merton 1973 s intertemporal capital asset pricing model icapm, investors require higher compensation for holding stocks that are not suited for hedging against changes in. Pricing intertemporal risk when investment opportunities. Pdf an intertemporal capital asset pricing model researchgate.
The intertemporal capital asset pricing model springerlink. We develop an intertemporal asset pricing model where cashflow news, discountrate news, and their second moments are priced by the market. It is a linear factor model with wealth as state variable that forecast changes in the distribution of future returns or income. Intertemporal capital asset pricing model without state variables. Security analysis, portfolio management, and financial. Security analysis, portfolio management, and financial derivatives integrates the many topics of modern investment analysis. It provides a balanced presentation of theories, institutions, markets, academic research, and practical applications. Merton 1973 introduces an intertemporal capital asset pricing model icapm in which an assets expected return depends on its covariance with the market. The model is to maximize the expected utility of lifetime consumption and to assume the investors trade continuously. The intertemporal capital asset pricing model with dynamic conditional correlations. A financial model that takes into account major sources of risk when optimizing consumption over a period of time. It also provides a theory to identify potential forwardlooking risk premia for use in factorbased investment strategies. The intertemporal capital asset pricing model icapm is a consumptionbased assetpricing model. Lo and jiang wangy october 5, 2001 abstract we derive an intertemporal capital asset pricing model with multiple assets and heterogeneous investors, and explore its implications for the behavior of trading volume and asset returns.
An intertemporal model for the capital market is deduced from the portfolio selection behavior by an arbitrary number of investors who act so as to maximize the expected utility of lifetime consumption and who can trade continuously in time. Building on recent advances in the finance literature, the paper proposes a fourfactor model motivated by the intertemporal capital asset pricing model icapm, and based on. The derivation of the multifactor intertemporal capital asset pricing model icapm. The intertemporal capital asset pricing model icapm predicts that an unobservable factor capturing changes in expected market returns should be priced in the cross section. Consumption capital asset pricing model ccapm definition. In the test of intertemporal capital asset pricing modelicapm following campbell 1993, the state variables are identified as the predictors forecasting the. Merton an intertemporal model for the capital market is deduced from the portfolio selection behavior by an arbitrary number of investors who aot so as to maximize the expected utility of lifetime consumption and who can trade continuously in time. Engleb,1 a department of economics and finance, zicklin school of business, baruch college, one bernard baruch way, box 10225, new york, ny 10010, usa b new york university, stern school of business, 44 west fourth street, suite 962, new york, ny 10012, usa. Merton 1973 introduces an intertemporal capital asset pricing model icapm in which an asset s expected return depends on its covariance with the market portfolio and with state variables that proxy for changes in investment opportunity set. Michael brennan is emeritus professor, and ashley wang is a doctoral candidate at the anderson school, ucla.
Unlimited viewing of the articlechapter pdf and any associated supplements and figures. Estimation and test of a simple model of intertemporal. The rst is intertemporal asset pricing model literature as in merton 1973. January 23, 2005 job market paper abstract this paper examines the anomaly, first reported by sloan 1996, that the market misprices stocks of firms with extreme high or low accruals. Econophysics and capital asset pricing splitting the atom of systematic risk.
Pdf risk aversion and intertemporal substitution in the. Investment opportunities in the stock market may deteriorate either because expected. Solve static problem instead of intertemporal problem 2. After aggregating demands and requiring market clearing, the equilibrium relationships among expected returns are derived, and contrary to the classical capital asset pricing model, expected returns on risky assets may differ from the riskless rate even when they have no systematic or market risk. The intertemporal capm expands investor behavior to include values of future state variables, su ch as labor income, consumer goods.
Evidence from tests of an intertemporal capital asset pricing model mozaffar khan university of toronto this draft. Icapm assumes that investors will try to hedge their risky positions based on current and projected factors such as inflation. Conventional asset pricing models assume, rather unrealistically, that investors live for exactly a single time span, during which they will confront no potential changes in consumption preferences, liquidity needs, or tolerance for risk. We begin by developing an intertemporal capital asset pricing ple assets in the spirit of mertons icapm merton, 1973.
Estimation and test of a simple model of intertemporal capital asset pricing michael j. Pdf the intertemporal capital asset pricing model with. Intertemporal capital asset pricing model, famafrench three factor model. The capital asset pricing model capm is an example of an equilibrium model in which asset prices are related to the exogenous data, the tastes and endowments of investors although, as we shall see below, the capm is often presented as a relative pricing model.
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