Stock returns and consumption factors in the Australian market: Cross-sectional tests

We test conditional consumption capital asset pricing models (CCAPMs) in the Australian equity market. The conditional variables used are Lettau and Ludvigson’s (2001a, b) consumption–wealth ratio, Campbell and Cochrane’s (1999) surplus consumption ratio and Santos and Veronesi’s (2006) labour income to consumption ratio. We examine the cross-sectional implications of these variables using the Fama–French 25 size and book-to-market portfolios and Australian industry portfolios. The Fama–MacBeth (1973) cross-sectional regressions on the 25 size/book-to-market portfolios show that the conditional models perform better than the unconditional models. However, these conditional models cannot outperform the Fama–French three-factor model. The conditional CCAPM, with the labour income to consumption ratio as a scaling factor, can match more closely the performance of the Fama–French three-factor model. We also find that consumption growth is non-contemporaneously related to portfolio returns.