External Habit and the Cyclicality of Expected Stock Returns

31 Pages Posted: 26 Apr 2000

See all articles by Thomas D. Tallarini

Thomas D. Tallarini

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Harold H. Zhang

University of Texas at Dallas - Naveen Jindal School of Management; China Academy of Financial Research (CAFR)

Date Written: 2005

Abstract

We estimate an equilibrium asset pricing model in which agents' preferences have an unobserved external habit using the efficient method of moments (EMM). Given the estimated structural parameters we examine the cyclical behavior of expected stock returns in the model. We find that the estimated structural parameters imply countercyclical expected stock returns as documented in existing empirical studies. The model, however, is still rejected at the one percent level. Detailed examination of the moment conditions in our estimation indicates that the model performs reasonably well in matching the mean of the stock returns, but it fails to capture the higher order moments such as variance, skewness and kurtosis.

JEL Classification: G12

Suggested Citation

Tallarini, Thomas D. and Zhang, Harold Huibing, External Habit and the Cyclicality of Expected Stock Returns (2005). FEDS Working Paper No. 2005-27. Available at SSRN: https://ssrn.com/abstract=221488 or http://dx.doi.org/10.2139/ssrn.221488

Thomas D. Tallarini

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Harold Huibing Zhang (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

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