Asset Pricing in Consumption Models: A Survey of the Literature

This paper attempts to provide a survey of asset-pricing models based on the principle of maximization of expected utility. I will begin my analysis by setting out a simplified, discrete-time version of the model that was developed independently by Lucas (1978) and Breeden (1979). Since those studies appeared, intertemporal general-equilibrium models have come to occupy an increasingly important place in the economic literature on asset pricing. A common characteristic of those models is that prices and yields of financial assets are linked, in a general-equilibrium context, to investors’ decisions about consumption and savings. The yield structure predicted by these models is therefore intimately tied to the nature of investors’ preferences and, in particular, to the parameters of risk aversion and intertemporal substitutions. Moreover, in contrast to the capital-asset-pricing (CAPM) model of Sharpe (1964) and Lintner (1965), intertemporal generalequilibrium models identify clearly the underlying economic forces that influence the risk-free real interest rate and the compensation that investors earn by accepting risk.1