What Is the Intertemporal Capital Asset Pricing Model?
The Intertemporal Capital Asset Pricing Model (ICAPM) is a consumption-based capital asset pricing model (CCAPM) that assumes investors hedge risky positions. ICAPM is an extension of CAPM and was introduced by Nobel laureate Robert Merton in 1973.
Understanding the Intertemporal Capital Asset Pricing Model (ICAPM)
The Intertemporal Capital Asset Pricing Model (ICAPM) is a consumption-based asset-pricing model. Whereas CAPM uses market movement to predict a stock's return, CCAPMs explain the market's movement or a security's movement by its relationship to aggregate consumption. In CAPM, a security's return will be proportional to its risk, or market beta. In CCAPM, a stock's return will occur in relation to aggregate consumption, indicated by consumption beta.
Like CAPM and CCAPM, ICAPM also predicts the expected return on a security. It offers further precision by taking into account how investors participate in the market. Most investors participate in markets for multiple years, and over longer time periods, investment opportunities might shift as expectations of risk change, resulting in situations in which investors may wish to hedge. For example, an investment may perform better in bear markets, and an investor may consider holding that asset if a downturn in the business cycle is expected. The ICAPM model, therefore, accounts for one or more hedging portfolios that an investor may use to address these risks. ICAPM covers multiple time periods, so multiple beta coefficients are used.