An empirical investigation of the consumption based Capital Asset Pricing Model using a modified variance-ratio test

A chi-square statistic is constructed that compares variance ratios and mean simple returns from data with those implied by an asset pricing model. The statistic is applied to the Consumption based Capital Asset Pricing Model with time non-separable preferences. It favors habit persistence for annual data, time-separability for quarterly data, and durability for monthly data, respectively. Introduction of time non-separability yields only a marginal improvement. The power of the test is high when alternative hypotheses are formed by varying the relative risk aversion coefficient. It is lower for alternative hypotheses generated by varying the time non-separability parameter, especially for durability. The author would like to thank Craig Burnside, David DeJong, John Duffy, and Steve Husted for their comments on previous versions of the paper.