CCAPM Flashcards
(5 cards)
Two examples of real-world assets with low market beta but high consumption beta
Private Health Insurance Stocks: n economic downturns, especially severe ones, consumption contracts and individuals may defer medical care,
High-End Consumer Discretionary Goods:
These assets are very sensitive to aggregate consumption patterns
Does CAPM or CCAPM better capture investor preferences during recessions?
Investors care about consumption smoothing
Consumption beta directly tracks marginal utility shocks
What happens to a stock with positive payoff in low consumption states under CCAPM?
Its expected return falls — the asset becomes more valuable, and hence more expensive, due to its hedging properties.
What are the key assumptions behind the Consumption Capital Asset Pricing Model (CCAPM)?
Time-Separable Utility:
Utility at time t depends only on consumption at timet, and total utility is the sum of discounted period utilities.
CRRA Preferences (Constant Relative Risk Aversion):
Representative Agent:
The economy can be described by a single, rational, forward-looking agent maximizing lifetime utility.
Rational Expectations:
Agents form expectations using all available information and update them optimally.
Frictionless Markets:
No transaction costs, taxes, or constraints on borrowing or short-selling.
Complete Markets:
All risks can be traded and insured against.
No Idiosyncratic Consumption Risk:
Consumption shocks are assumed to be fully diversified; only aggregate consumption risk matters.
What does “consumption smoothing” imply about the types of assets investors prefer?
Investors prefer assets that perform well in bad times, i.e., when aggregate consumption is low.
Such assets help stabilize marginal utility across time — they provide income when it’s most valuable.
Assets with low or negative covariance with consumption growth are more valuable.
