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
Date Written: July 3, 2014
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: Suggested Citation