Poor Performance of Consumption-Based Asset Pricing Models - Article Example

Article review: Explaining the Poor Performance of Consumption-based Asset Pricing Models The Campbell and Cochrane examine a variety of models used in explaining asset pricing. The topic in focus seems to have attracted a number of studies. In each of the studies for instance, the authors looked a number of factors including the validity of the performance of a given model. In this sense, the author of this article attempted to provide his explanations concerning each of the previous work. The author did not generalize the concept of asset pricing; he focused on various segments of the topic asset pricing. The approach employed helps the author to cover a number of concepts within the topic in detail. The author explored a number of topics including consumption-based asset pricing among others. In his explanation, the author observed the weakness of each of the pricing model. Largely, the author focused on the factors that validated the models developed for explaining the concept of asset pricing. The acceptance or the rejection of the models developed in explaining the asset pricing often considered accounting principle applied within a given country. While the article looks at the advances made in accounting concerning the topic of asset pricing, the article does not accept all the models used in explaining this principle. Instead, it examined weaknesses of each of the models used in explanation. This approach is critical in defining the concept as well as contemplating to rectify or build from the weaknesses made by previous critics. A number of authors contributing to this topic have made various explanations concerning their views of the consumption-based asset model. Hansen and Singleton canonical consumption based model for instance, focused on the investors and timeline used in asset development as the variables that affected the pattern of asset pricing (Beridze 165). Hansen and Singleton model attempted to disapprove the U.S data model used in setting the asset pricing (Campbell and Cochrane 274). Largely, the argument bordering this concept focused on the validity of the variables used in determining the consumer based asset pricing. According to the argument presented, the variable investigated would influence the outcome of the accounting system. In this sense, the article seems to focus on developing an acceptable model, which does not only attract criticism, but also support from various think tanks. I think the approach employed in investigating the models employed in asset pricing is instrumental in developing future models. The article provides a comprehensive view of each of the models used. Thus, it does not reject the models, but provides reasons why the models are worth rejecting. In this sense, the author seemed to have been playing an investigative role as opposed to a judgmental role. When the article focused on the consumer based asset consumption model for instance, the article examined related arguments projected by various authors concerning the validity of the arguments used in developing the model. In this sense, the article tends to provide a platform for investigating the validity of any of the asset pricing system. The author has examined the acceptability of the single factor models and multifactor models. Apparently, each of the above-mentioned models applied a given regression method in settling at a given principle. Thus, in settling on the validity of any of the models highlighted, the article has sought to explain acceptability or reasons that should warrant rejection of the model. The article holds the view that all the models employed in asset pricing can be rejected (Campbell and Cochrane 273). However, the author is quick to note that the important factor in building the models is the approximation made. Arguably, in all the models developed concerning the asset-pricing concept, approximation method seems to be the central factor that creates the differences. The article explored the compared the performance of the simple static Capital Asset Pricing Model and canonical consumption-based model settling that the later performed no better than the former. This argument seems to cement the early argument concerning acceptability or rejection of the asset-pricing model. Critics attempting to disapprove the two models employed the concept of regression in investigating the acceptability or the variation produced by any of the above models (Singleton 440). Arguably, investigative studies often look at a number of factors that would lead to acceptability or would promote the rejection of the model. In this case, the later and the former are factors that command equal measure. Thus, in accepting or rejecting the model, the critics have to draw their arguments based on preexisting facts. The article observed a number of comments made for each of the accounting models prompted for use in asset pricing. Observably, each model has its weaknesses hence the call for rejection or the attempts geared to improving the existing model. The article seems to suggest that a number of authors settle that multifactor models have improved on Capital Asset Pricing Model. Proponents of the above argument believe that price ratio is a vital variable that influences market expectations (Campbell and Cochrane 275). Thus, if the market expectation would change the variable used in calculating the asset prices would indicates similar effects. Arguably, this observation seems to support that argument that market conditions are not static factors. In addition, the macroeconomic factors often influence the performance of these variables. In this view, the article seems to provide an alternative view of rejecting or accepting the models set for asset pricing. An attempt to provide a reason for an argument is instrumental in defining the validity of argument. Seemingly, the explanations provided for any of the above cases tend to borrow much from this concept. The deterrent views floated by various authors make the article concrete in achieving its objective. Largely, the author has not narrowed the concept of his stud; instead, he has provided an insight in other areas of accounting that do not only need attention when it comes to evaluating asset pricing, but also instrumental in explaining the market trends. According to views of this article, the concept of developing the asset pricing is a multifaceted attempt, which brings together the views and the contribution of various critics. In addition, focus on this concept does not occur in isolation i.e. when other factors are constant; however, it has to factor considerations of other market factors. Probably, this could explain the argument presented over the rejection of all the models used in explaining essence of asset pricing. Particular, the articles view that all the models could be rejected beg answers on what criterion used in sampling or tabulating the data. Some of the issues that the article has pointed out successfully include providing successful information concerning need to reject a given model. An attempt to prove the above point seems to direct the reader towards failure of the models investigated. First, the argument presented concerning the failure of the canonical consumption-based model suggested that the approach used by the model in correcting financial risks and other aspects was not inclusive. Arguably, this illustrate the pattern employed in selecting the risks used in computation of the models as opposed to obvious market factors that would influence the behavior of the variables selected in developing creating the model. If one of the risk factors ignored in the model, for instance, amount to a big discrepancy, then the factor ignored in the model is worth revisiting. Probably, this explains the historical developments in the asset pricing. Other arguments concerning the validity or acceptability of asset pricing models are the consistency of the variables used in designing the concept (Singleton 403). The article highlights the consumption-based model as one of pricing models that history has judged as inconsistent in explaining the asset pricing. The explanation supporting the above investigated the behavior of factors that contribute to a given outcome in the asset market. According to Cheng, utility functions are instrumental in defining the persistence of the habits investigated in asset pricing (314). The author looks at the divulging factors that would draw one from considering one model or a factor would promote critics into supporting the system used in the developing this models. The article has concentrated in explaining the idea behind Capital Asset Pricing Model. In its attempt, it has explored the functions of the preexisting asset pricing models as well as their failures. In developing the model, contributing authors have provided reasons for their preferences. One of the notable preferences highlighted is poor performance of the canonical consumption based model when handling factors that influence pricing (Cheng 313). The view presented in the article seems to highlight infallibility of the model; however, in quick rejoinder the author points on the CAPM as the model that seems to provide a satisfactory result. In this sense, the focus looks at modality of arriving at a given conclusion when the factors considered as variables are present. This means that the validity or the acceptance of CAPM system tend to provide a reflective result as opposed to static result provided by other variables. Measurement of errors is a primary factor that seems to define the authenticity of the model used for asset pricing. The technique employed in measuring the errors has direct effects on the results. In addition, setting the intervals helps in illustrating the probable behavior of model. The effects yielded whenever conditions within the market change seem to reverberate thereby influencing the growth and consumption factors (Mehra 123). Addressing the behavior of the model without addressing the trends in the market would ignore critical components hence the invalid result. Seemingly, these are some of the factors behind the settlement that CAPM is the appropriate model of measuring asset pricing. The article looks at the study of the artificial data used in the developing of the asset-pricing model. The study of the economic model for instance, focused on the conditions that would define the outcome of the standard consumption. Various authors contributing to this factor have indicated the ingredients that are instrumental in defining the prices (Campbell and Cochrane 271). Some these ingredients identified include stock price decline, habit level, and risk aversion trends. The author has used the ingredients to illustrate sensitivity of the function as well as the behavior of other functions involved in determining the asset prices. The calculations made in the article draw attention of the reader to the validity of the functions used in integrating the variables. If the consumption trends are to assume any of the calculation presented, then argument presented about the rejection of all the models is true. Arguably, the author has been able to introduce concepts with the financial market that other models had ignored. Further, the reasons provided in each case tend to support the view of the author concerning the Capital asset pricing model. Apparently, looking at the calculation related factors often lead the calculations towards a given direction. Largely, the predictability of the outcome would depend on the direction assumed by calculation (Haliassos 126). In essence, the author has settled that validity of the asset models depend on the calculations developed alongside the factors mentioned in support of the regression used. In case where all the variables that would affect the outcome are present, then the model has factored nearly all the required components. However, this does not mean that it would be acceptable as the asset pricing system. In conclusion, the author has noted in his investigation that the models highlighted provide a comprehensive measure on returns as opposed to consumption data. The portfolio factors are instrumental in defining the variance of the measurement. Further, determination of risk factors and deeper economic forces seems to illustrate the outcome of any model used in investigation. This tends to explain why pricing errors and consumption trends are among factors considered by the author in defining the model for asset pricing. The article has examined various models used in asset pricing. Largely, the investigation of the models projected the failures of models such as canonical consumption based model. The article does not only provide the reasons for rejection of the discussed models, but looks at various aspects that are instrumental in defining the asset-pricing model. Finally, the author settles on capital asset pricing model as one of the elaborate and comprehensive models used in asset pricing. The author has highlighted various areas including functional models that make it suitable for asset pricing. Work Cited Beridze, Lado. Economics of Emerging Markets. London: Nova Publishers. 2008. Print. Campbell, Y. John and Cochrane, John. Explaining the Poor Performance of Consumption-based Asset Models. The Journal of Finance. Vol. LV, No. 6. Dec. 2000. Print. Cheng, Bing. Asset Pricing: A Structural Theory Applications. Washington DC: World Scientific. 2008. Print. Haliassos, Michael. Financial Innovation: Too Much or Too Little? New York: MIT Press. 2012. Print. Mehra, Rajnish. Handbook of the Equity Risk Premium. London: Elsevier. 2011. Print. Singleton. J. Kenneth. Empirical Dynamic Asset Pricing: Model Specification and Econometric Assessment. Kentucky: Princeton University Press. 2009. Print. Read More