Consumption Asset Pricing and the Term Structure

We investigate the relationship between consumption and the term structure using UK interest rate data. We demonstrate that the term structure contains information about future economic activity since the yield spread has forecasting power for future consumption growth. Further we analyze the ability of the consumption based capital asset pricing model (C-CAPM) using traditional power utility, two habit formation specifications proposed by Abel (1990) and Campbell and Cochrane (1999) and novelly, the housing C-CAPM proposed by Piazzesi et al. (2007) to characterize the term structure of interest rates. Our findings are supportive of the habit formation specification of Campbell and Cochrane (1999), other models fail to yield economically plausible parameter values