Impact of consumer confidence on the expected returns of the Tokyo Stock Exchange: A comparative analysis of consumption and production-based asset pricing models

Most single-factor and multifactor asset pricing models constitute special cases of the consumption-based asset pricing theory, in which investors’ marginal utility is the key determinant of asset prices. However, in recent years, production-based asset pricing models have been extraordinarily successful in correctly pricing a wide range of anomaly portfolios that are typically mispriced in previous research. In parallel, research on conditioning information has contributed to significantly improve the performance of classic consumption-based asset pricing models. On this basis, in this paper we conduct an in-depth research on the performance of consumption and production-based asset pricing models on the Tokyo Stock Exchange, for the period from 1992 to 2018, in order to test to what extent consumer confidence helps consumption models to correctly capture shifts in the investment opportunity set of investors. To overcome the constraints imposed by the periodicity of macroeconomic data, we use a factor-mimicking portfolio approach that allows us to test the performance of the models into consideration at different frequencies. Our results suggest that the consumer confidence index for Japan helps consumption-based asset pricing models outperform production-based models for different anomaly portfolios. Conversely, in those cases where consumption models perform worse, the production models also perform poorly. These results help to partially reconcile the results provided by the consumption and production models, and constitute a step forward for the purpose of identifying the fundamental risk factors that drive asset prices.