DP4067 C-CAPM and the Cross-Section of Sharpe Ratios

Author(s): Paul Söderlind
Publication Date: September 2003
Keyword(s): consumption-based asset pricing, habit persistence, idiosyncratic risk, multivariate GARCH, recursive utility
JEL(s): E13, E32, G12
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4067

This Paper studies whether the consumption-based asset-pricing model can explain the cross-section of Sharpe ratios. The constant relative risk aversion (CRRA) model and several extensions (habit persistence, recursive utility and idiosyncratic shocks) all imply that the Sharpe ratio is linearly increasing in the asset?s correlation with aggregate consumption growth. Results from quarterly data on 40 US portfolios (1947?2001) and 10 international portfolios (1957/1971?2001) suggest that both the unconditional and conditional C-CAPM have serious problems: there is a great deal of variation in Sharpe ratios, but most portfolios have relatively similar and low correlations with aggregate consumption growth.