Investor's wiki

Consumption Capital Asset Pricing Model (CCAPM)

Consumption Capital Asset Pricing Model (CCAPM)

What Is the Consumption Capital Asset Pricing Model (CCAPM)?

The consumption capital asset pricing model (CCAPM) is an extension of the capital asset pricing model (CAPM) that utilizes a consumption beta rather than a market beta to make sense of expected return premiums over the risk-free rate. The beta part of both the CCAPM and CAPM formulas implies a liability that can't be diversified away.

Understanding the Consumption Capital Asset Pricing Model (CCAPM)

The consumption beta depends on the volatility of a given stock or portfolio. The CCAPM predicts that an asset's return premium is proportional to its consumption beta. The model is credited to Douglas Breeden, a finance teacher at Fuqua School of Business at Duke University, and Robert Lucas, an economics teacher at the University of Chicago who won the Nobel Prize in Economics in 1995.

The CCAPM gives a fundamental comprehension of the relationship among wealth and consumption and an investor's risk aversion. The CCAPM functions as a asset valuation model to let you know the expected premium investors expect to buy a given stock, and what that return is meant for by the risk that comes from consumption-driven stock price volatility.

The quantity of risk connected with the consumption beta is estimated by the developments of the risk premium (return on asset and risk-free rate) with consumption growth. The CCAPM is helpful in assessing how much stock market returns change relative to consumption growth. A higher consumption beta suggests a higher expected return on risky assets. For example, a consumption beta of 2.0 would suggest an increased asset return requirement of 2% in the event that the market increased by 1%.

The CCAPM incorporates many forms of wealth past stock market wealth and gives a system to understanding variation in financial asset returns throughout many time spans. This gives an extension of the CAPM, which just considers one-period asset returns.

The formula for CCAPM is:
R=Rf+ő≤c(Rm‚ąíRf)where:R=Expected¬†return¬†on¬†a¬†securityRf=Risk-free¬†rateő≤c=Consumption¬†betaRm=Return¬†on¬†the¬†market\begin &R = R_f + \beta_c ( R_m - R_f ) \ &\textbf \ &R = \text \ &R_f = \text \ &\beta_c = \text \ &R_m = \text \ \end

CCAPM versus CAPM

While the CAPM formula depends on the market portfolio's return to foresee future asset prices, the CCAPM depends on aggregate consumption. In the CAPM, the market return is commonly addressed by the return on the S&P 500. Risky assets make vulnerability in an investor's wealth, not entirely settled in that frame of mind by the market portfolio utilizing the market's beta of 1.0. CAPM expects that an investor cares about the market return and how their portfolio's return differs from that return benchmark.

In the CCAPM formula, then again, risky assets make vulnerability in consumption ‚ÄĒ how much a person will spend becomes dubious in light of the fact that the level of wealth is questionable due to investments in risky assets. The CCAPM expects investors are more worried about how their portfolio returns shift from an unexpected benchmark in comparison to the overall market.

Features

  • Consumption beta is the coefficient of the regression of an asset's returns and consumption growth, where the CAPM's market beta is the coefficient of the regression of an asset's returns on the market portfolio returns.
  • The CCAPM predicts that an asset's return premium is proportional to its consumption beta.