Consumer Confidence and Asset Prices: Some Empirical Evidence

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Abstract
We explore the conditional version of the CAPM and the CCAPM using the methodology of Lettau and Ludvigson (2001). As a conditioning variable, we use the Index of Consumer Sentiment from the University of Michigan. The ability of the confidence index to explain the cross-section of the 25 Fama-French portfolios is comparable to that of the consumption-to-wealth ratio advocated by Lettau and Ludvigson, or the default spread employed by Jagannathan and Wang (1996). As suggested by further analysis, the improved cross-sectional performance is related to the fact that the conditional market betas of small stocks are significantly more sensitive to the business cycle than those of large stocks.

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