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Testing Habits in an Asset Pricing ModelStefano D'AddonaUniversity of Rome 3; City University of New York, CUNY Baruch College - Zicklin School of Business - Department of Economics and Finance Melisso BoschiUniversity of Rome 3; Centre for Applied Macroeconomic Analysis (CAMA) Aditya Goenkaaffiliation not provided to SSRN March 3, 2012 Abstract: We develop an asset pricing model with external habit formation. The model predicts that the effect of consumption shocks on the equity premium depends on the business cycle. We test this empirical implication using a VAR model of the U.S. postwar economy whose parameters are estimated conditioning on Markov-switching regimes that shift according to the business cycle phases. The results show that the response of the equity premium to consumption shocks is insignificantly different across the business cycle phases of the economy. We interpret this result as evidence against the habit formation hypothesis.
Number of Pages in PDF File: 41 Keywords: Habit formation, Equity premium, Business cycles, Markov-switching models, Regime-dependent impulse response functions JEL Classification: E21, E32, E44, G11, G12 working papers seriesDate posted: March 16, 2012Suggested CitationContact Information
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