FINE 3200 Lecture Notes - Lecture 5: The Intercept, S&P 500 Index, Standard Deviation
Document Summary
Therefore, it is expected that the fama-french model with consumption provides a better explanation of returns than does the model with consumption alone. Wealth and consumption should be positively correlated and, therefore, market volatility and consumption volatility should also be positively correlated. Periods of high market volatility might coincide with periods of high consumption volatility. However, to the extent that wealth and consumption are correlated, both versions of the capm might represent patterns in actual returns reasonably well. To see this formally, suppose that the capm and the consumption-based model are approximately true. According to the conventional capm, the market price of risk equals expected excess market return divided by the variance of that excess return. According to the consumption-beta model, the price of risk equals expected excess market return divided by the covariance of rm with g, where g is the rate of consumption growth.
