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 focuses on a consumption beta instead of a market beta to explain expected return premiums over the risk-free rate. The CCAPM predicts that asset premiums are proportional to consumption betas. The model is credited to Douglas Breeden, a finance professor at Fuqua School of Business at Duke University, and Robert Lucas, an economics professor at the University of Chicago who won the Nobel Prize in Economics in 1995.

The formula:

Calculating the formula for Consumption Capital Asset Pricing Model (CCAPM).

BREAKING DOWN 'Consumption Capital Asset Pricing Model - CCAPM'

While the CAPM relies on the market portfolio's return to predict future asset prices, the CCAPM relies on aggregate consumption. In the CAPM, risky assets create uncertainty in an investor's wealth, which is determined by the market portfolio (e.g., the S&P 500). In the CCAPM, on the other hand, risky assets create uncertainty in consumption — how much a person will spend becomes uncertain because the level of wealth is uncertain due to investments in risky assets. The quantity of market risk — the consumption beta — is measured by the movements of risk premium with consumption growth. The CCAPM is useful in estimating how much the stock market changes relative to consumption growth. A higher consumption beta implies a higher expected return on risk assets. For instance, a consumption beta of 2.0 would imply an increase of asset return of 2% if the market increased by 1%.

The CCAPM incorporates many forms of wealth beyond stock market wealth and provides a framework for understanding variation in financial asset returns over many time periods. This provides an extension of the CAPM, which only takes into account one-period asset returns. The CCAPM also provides a fundamental understanding of the relation between wealth and consumption and an investor's risk aversion.

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