Market segmentation and stock price behaviour

We employ Campbell and Shiller's (1989) VAR methodology to examine the rela tive performance of the CAPM and the consumption-CAPM. We find that althoug h neither provides a complete description of stock price behaviour, the for mer clearly dominates the latter. We then consider the implications for sub -sectors of the market. According to the CAPM, subsector returns depend on the covariance of sub-sector returns with market returns. However, if analy sts are more skilled at eliminating mis-pricing in sub-sectors of the marke t than in the market as a whole, the required return on a sectoral portfoli o may depend only on the expected return variance within that sub-sector. U sing quarterly UK data for five industry-based portfolios, we find little s upport for the covariance model at the sectoral level, whereas the own-vari ance model fares better. It seems therefore that moving from return varianc es to covariances produces little if any improvement in the performance of the CAPM.