Capital Asset Pricing Model and Stochastic Volatility: A Case study of India

Bansal and Yaron (2004) demonstrate, by calibration, that the Consumption-Based Capital Asset Pricing Model (CCAPM) can be rescued by assuming that consumption growth rate follows a stochastic volatility model. They show that the conditional equity premium is a linear function of conditional consump...

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Bibliographic Details
Published inIDEAS Working Paper Series from RePEc
Main Authors Fung, Ka Wai Terence, Demir, Ender, Zhou, Lu
Format Paper
LanguageEnglish
Published St. Louis Federal Reserve Bank of St. Louis 01.01.2014
Subjects
Capital assets
Volatility
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Summary:Bansal and Yaron (2004) demonstrate, by calibration, that the Consumption-Based Capital Asset Pricing Model (CCAPM) can be rescued by assuming that consumption growth rate follows a stochastic volatility model. They show that the conditional equity premium is a linear function of conditional consumption and market return volatilities, which can be estimated handily by various Generalized Autoregressive Conditonal Heterskedasticity (GARCH) and Stochastic Volatility (SV) models. Using the data from India, we find that conditional consumption and market volatilities are capable of explaining cross-sectional return differences. Also, the model prediction is consistent with observed declining equity premium.