An alternative representation of the C-CAPM with higher-order risks

Georges DIONNE; Jingyuan LI; Cédric OKOU

doi:10.1057/s10713-023-00085-2

An alternative representation of the C-CAPM with higher-order risks

Georges DIONNE^*, Jingyuan LI, Cédric OKOU

^*Corresponding author for this work

Department of Finance and Insurance

Research output: Journal Publications › Journal Article (refereed) › peer-review

Abstract

This paper exploits the concept of expectation dependence to propose an alternative representation of the consumption-based capital asset pricing model (C-CAPM). While the first-degree expectation dependence (FED) drives the C-CAPM’s riskiness for a risk-averse investor, the second-degree expectation dependence (SED) is required to account for the downside risk faced by a prudent investor. Theoretical and empirical assessments reveal that the expectation dependence-based C-CAPM can realistically match equity and variance risk premia. The consumption SED risk emerges as a fundamental source of uncertainty driving asset prices.

Original language	English
Number of pages	40
Journal	GENEVA Risk and Insurance Review
Early online date	5 Jun 2023
DOIs	https://doi.org/10.1057/s10713-023-00085-2
Publication status	E-pub ahead of print - 5 Jun 2023

Bibliographical note

We are indebted to the editors Alexander Muermann and Casey Rothschild and two anonymous referees for very helpful comments. We thank Louis Eeckhoudt, Carole Bernard, and Bruno Feunou for fruitful discussions. This contribution is free of any conflicts of interest, including all financial and non-financial interests and relationships.

Keywords

C-CAPM
Expectation dependence
Higher-order risk
equity risk premium
variance risk premium

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10.1057/s10713-023-00085-2

Cite this

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title = "An alternative representation of the C-CAPM with higher-order risks",

abstract = "This paper exploits the concept of expectation dependence to propose an alternative representation of the consumption-based capital asset pricing model (C-CAPM). While the first-degree expectation dependence (FED) drives the C-CAPM{\textquoteright}s riskiness for a risk-averse investor, the second-degree expectation dependence (SED) is required to account for the downside risk faced by a prudent investor. Theoretical and empirical assessments reveal that the expectation dependence-based C-CAPM can realistically match equity and variance risk premia. The consumption SED risk emerges as a fundamental source of uncertainty driving asset prices.",

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AU - LI, Jingyuan

AU - OKOU, Cédric

N1 - We are indebted to the editors Alexander Muermann and Casey Rothschild and two anonymous referees for very helpful comments. We thank Louis Eeckhoudt, Carole Bernard, and Bruno Feunou for fruitful discussions. This contribution is free of any conflicts of interest, including all financial and non-financial interests and relationships.

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N2 - This paper exploits the concept of expectation dependence to propose an alternative representation of the consumption-based capital asset pricing model (C-CAPM). While the first-degree expectation dependence (FED) drives the C-CAPM’s riskiness for a risk-averse investor, the second-degree expectation dependence (SED) is required to account for the downside risk faced by a prudent investor. Theoretical and empirical assessments reveal that the expectation dependence-based C-CAPM can realistically match equity and variance risk premia. The consumption SED risk emerges as a fundamental source of uncertainty driving asset prices.

AB - This paper exploits the concept of expectation dependence to propose an alternative representation of the consumption-based capital asset pricing model (C-CAPM). While the first-degree expectation dependence (FED) drives the C-CAPM’s riskiness for a risk-averse investor, the second-degree expectation dependence (SED) is required to account for the downside risk faced by a prudent investor. Theoretical and empirical assessments reveal that the expectation dependence-based C-CAPM can realistically match equity and variance risk premia. The consumption SED risk emerges as a fundamental source of uncertainty driving asset prices.

KW - C-CAPM

KW - Expectation dependence

KW - Higher-order risk

KW - equity risk premium

KW - variance risk premium

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DO - 10.1057/s10713-023-00085-2

M3 - Journal Article (refereed)

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SN - 1554-964X

JO - GENEVA Risk and Insurance Review

JF - GENEVA Risk and Insurance Review

ER -

An alternative representation of the C-CAPM with higher-order risks

Abstract

Bibliographical note

Keywords

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