Habit Formation and Returns on Bonds and Stocks

40 Pages Posted: 3 Nov 2008

See all articles by Jessica A. Wachter

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Multiple version iconThere are 5 versions of this paper

Date Written: May 2002


This paper proposes a habit formation model that explains the failure of the expectations hypothesis documented by Campbell and Shiller (1991) and Fama and Bliss (1987). The model also produces positive excess returns on long-term bonds, an upward sloping average yield curve, and allows for realistic levels of time-variation in the mean of consumption growth. The model generates a novel empirical prediction: Long lags of consumption growth predict the short-term interest rate with a negative sign. This prediction is shown to be strongly supported by the data.

Suggested Citation

Wachter, Jessica A., Habit Formation and Returns on Bonds and Stocks (May 2002). NYU Working Paper No. FIN-01-024, Available at SSRN: https://ssrn.com/abstract=1294559

Jessica A. Wachter (Contact Author)

University of Pennsylvania - Finance Department ( email )

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