Good-Specifc Habit Formation and the Cross Section of Expected Returns
53 Pages Posted: 22 Mar 2008 Last revised: 15 Sep 2013
Date Written: December 1, 2007
I study the cross-section of expected stock returns in a general equilibrium framework where agents form habits over individual varieties of goods. Goods are produced by monopolistically competitive firms whose income and price elasticities of demand depend on the habit formation of the consumers. Firms that produce goods with a high habit level relative to consumption have low income and price elasticities, set high prices for their product, and have low expected returns on their stock. Taking this prediction to the data, I find a return spread that is hard to explain by commonly used empirical asset pricing models.
Keywords: Habit formation, Cross Section, Expected Returns, Markups
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