We show that the external habit-formation model economy of Campbell and Cochrane (1999) can explain why the Capital Asset Pricing Model (CAPM) and its extensions are betterapproximate asset pricing models than is the standard onsumption-based model. The model economy produces time-varying...

type="main" <title type="main">ABSTRACT</title> <p>Mean-variance portfolio theory can apply to streams of payoffs such as dividends following an initial investment. This description is useful when returns are not independent over time and investors have nonmarketed income. Investors hedge their outside income streams. Then,...</p>