We propose a single-factor asset pricing model based on an indicator function of consumption growth being less than its endogenous certainty equivalent. This certainty equivalent is derived from generalized disappointment-aversion preferences, and it is located approximately 1 standard deviation below the conditional mean of consumption growth. Our single-factor model can explain the cross section of expected returns for size, value, reversal, profitability, and investment portfolios at least as well as the Fama-French multifactor models. Our results show strong empirical support for asymmetric preferences and question the effectiveness of the smooth utility framework, which is traditionally used in consumption-based asset pricing.
ASJC Scopus subject areas
- Economics and Econometrics