A Theoretical Extension of the Consumption-based CAPM Model

Abstract

We extend the Consumption-based CAPM (C-CAPM) model for representative agents with different risk attitudes. We introduce the concept of expectation dependence and show that for a risk averse representative agent, it is the first-degree expectation dependence rather than the covariance that determines C-CAPM’s riskiness. We extend the assumption of risk aversion to prudence and provide a weaker dependence condition than first-degree expectation dependence to obtain the values of asset price and equity premium. Results are generalized to higher-degree risk changes and higher- order representative agents, and are linked to the equity premium puzzle.