Finance and Economics Discussion Series: The Human Capital That Matters: Expected Returns and the Income of Affluent Households

We implement the human capital CAPM (HCAPM) using the income growth of high income households, rather than aggregate income growth, to proxy the return to human capital (HCRT). We find that identifying the HCRT with the income growth of affluent households, those who are most likely to hold stocks, substantially improves the performance of the HCAPM. Specifically, the pricing errors, R-square's, average returns on factor mimicking portfolios, and performance relative to other macro-finance models uniformly improve as the HCRT is identified with the income growth of successively more affluent households.