Consumption-based capital asset pricing model

The consumption-based capital asset pricing model (CCAPM) is a model of the determination of expected (i.e. required) return on an investment. The foundations of this concept were laid by the research of Robert Lucas (1978) and Douglas Breeden (1979). The consumption-based capital asset pricing model (CCAPM) is a model of the determination of expected (i.e. required) return on an investment. The foundations of this concept were laid by the research of Robert Lucas (1978) and Douglas Breeden (1979). The model is an extension of the capital asset pricing model (CAPM). Instead of basing the required return on the asset's performance relative to 'the market's', it factors in consumption as a means of calculating the required return. (Consumption is spending for acquisition of utility as opposed to investing which is spending for acquisition of future income.) The logic: risky assets create uncertainty in consumption — how much a person will be able to spend becomes uncertain, because the level of wealth is uncertain due to investments in risky assets. The required return will then be linked to an estimate of how stock market returns change relative to consumption growth - beta below. Formally, the CCAPM states that the expected risk premium on a risky asset, defined as the expected return on a risky asset less the risk free return, is proportional to the covariance of its return and consumption in the period of the return. The consumption beta is included, and the expected return is calculated as follows: