COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Post Office Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 738

"Risk and Return: Consumption Beta Versus Market Beta"

N. Gregory Mankiw and Matthew D. Shapiro

January 1985

Much recent work emphasizes the joint nature of the consumption decision and the portfolio allocation decision. In this paper, we compare two formulations of the Capital Asset Pricing Model. The traditional CAPM suggests that the appropriate measure of an asset’s risk is the covariance of the asset’s return with the market return. The consumption CAPM, on the other hand, implies that a better measure of risk is the covariance with aggregate consumption growth. We examine a cross-section of 464 stocks and find that the beta measured with respect to a stock market index outperforms the beta measured with respect to consumption growth.

JEL Classification: 313, 921

Keywords: Capital asset pricing model, consumption, risk, portfolio theory