Does Money Explain Asset Returns Theory and Empirical Analysis

K. C. CHAN, SILVER10 FORESI, and LARRY H. P. LANG*
ABSTRACT
A cash-in-advance model of a monetary economy is used to derive a money-based
CAPM (M-CAPM), which allows us to implement tests of asset pricing restrictions
without consumption data. A test as in Fama and MacBeth of the model suggests that
the money betas have some explanatory power for the cross-sectional variation of
expected returns; however, the model is rejected using conditional information.
Consistent with our predictions, estimates of the curvature parameter are lower than
those of the consumption CAPM (C-CAPM)and pricing errors of the M-CAPM tend
to be smaller than those of the C-CAPM.

WHILETHE RELATION BETWEEN asset prices and real macroeconomic variables
such as aggregate consumption has been extensively investigated, less attention
has been devoted to the relation between monetary aggregates and asset
prices that arises from models which incorporate a monetary sect0r.l It is often
argued that one possible reason for the rejection of the consumption-oriented
CAPM (C-CAPM)is the absence of monetary considerations. This paper takes
a step towards encompassing money into the C-CAPM and proposes a moneybased
CAPM (M-CAPM)that can be tested without using consumption data.
This M-CAPM is interesting in the way it captures the time-series and crosssectional
variation in stock returns and it provides insights in the possible
misspecification of existing C-CAPM models.