An Empirical Investigation of Consumption-Based Asset Pricing Models with Stochastic Habit Formation

Quarterly Journal of Finance, Forthcoming

42 Pages Posted: 12 Jun 2012 Last revised: 12 Aug 2014

See all articles by Qiang Dai

Qiang Dai

Braid Capital Pte Ltd.

Olesya V. Grishchenko

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: July 3, 2014

Abstract

We econometrically estimate and test a consumption-based asset pricing model with stochastic internal habit. The model departs from existing deterministic internal habit models by introducing shocks to the coefficients in the distributed lag specification of consumption habit and consequently an additional shock to the marginal rate of substitution. Habit shocks are persistent and provide an additional source of time variation in expected returns. Using returns on aggregate market and Treasury bond portfolios, we show that stochastic internal habit models provide a better explanation of time-variation in expected returns than models with either deterministic habit or stochastic external habit.

Keywords: asset pricing, consumption-based asset pricing models, habit formation, stochastic internal habit, aggregate equity and bond returns

JEL Classification: E21, G10, G12

Suggested Citation

Dai, Qiang and Grishchenko, Olesya V., An Empirical Investigation of Consumption-Based Asset Pricing Models with Stochastic Habit Formation (July 3, 2014). Quarterly Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2081961 or http://dx.doi.org/10.2139/ssrn.2081961

Qiang Dai

Braid Capital Pte Ltd. ( email )

Singapore

Olesya V. Grishchenko (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-2981 (Phone)

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