Consumption-Based Asset Pricing with a Reference Level: New Evidence from the Cross-Section of Stock Returns

This paper presents an empirical evaluation of recently proposed asset pricing models which extend the standard preference specification by a reference level of consumption. The novelty is that we use a broad cross-section of test assets, which provides a level playing field for a comparison to well-established benchmark models. We also motivate a specification that accounts for the return on human capital as a determinant of the reference level. We find that this extension does a good job in explaining the cross-sectional variation in average returns across the 25 Fama- French portfolios with pricing errors close to those of Lettau/Ludvigson's celebrated scaled factor models.