Asset Prices Under Habit Formation and Reference-Dependent Preferences
Federal Reserve Bank of Minneapolis
May 7, 2007
Journal of Business and Economic Statistics, Vol. 26, No. 2, 2008
This article explains the high level and the countercyclical variation of the equity premium in a consumption-based asset pricing model with low large-scale risk aversion. Investors have gain-loss utility over consumption relative to slowly time-varying habit. Stocks deliver low returns in recessions when consumption falls below habit; investors therefore require a high premium for holding stocks. The model's conditional moment restrictions are tested on consumption and asset returns data. The empirical estimate of large-scale risk aversion is low, whereas the estimate of loss aversion agrees with prior experimental evidence.
Number of Pages in PDF File: 43
Keywords: Asset pricing, Consumption, Equity premium, Habit formation, Loss aversion
JEL Classification: E21, G12
Date posted: April 16, 2006 ; Last revised: June 17, 2009
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