PORTFOLIO BEHAVIOUR AND ASSET PRICING IN A CHARACTERISTICS FRAMEWORK

We have applied the characteristics model to the problem of portfolio behaviour and asset pricing. By defining assets in terms of characteristics, we generated individual demands for assets which depended on the prices of assets, the technological relationship between assets and asset characteristics, and the individual's preferences for different characteristics. In general, the characteristics model cannot be readily aggregated across individuals. However, when we assumed that the assets-characteristics technology had a simple form which was common to all individuals, market-clearing conditions could be used to derive an asset pricing model. Finally, we showed that the characteristics model provides a unified approach to the problem of preference-based portfolio behaviour and asset pricing. A number of existing models can be interpreted as characteristics models: the state-preference model, the parameter-preference model, the capital asset pricing model and the inter-temporal capital asset pricing model.