Expected Returns and Habit Persistence

57 Pages Posted: 4 Nov 2000

See all articles by Yuming Li

Yuming Li

California State University

Date Written: June 23, 2000


Using a consumption-based asset pricing model with infinite-horizon nonlinear habit formation, Campbell and Cochrane (1999) show that low consumption in surplus of habit should forecast high expected returns. This article argues that the finite-horizon linear habit model also implies an inverse relation between expected returns and surplus consumption. This article also presents empirical evidence, which indicates that expected returns on stocks and bonds vary with surplus consumption implied by the habit models. The volatility of returns and the reward to volatility are also related to surplus consumption. However, less than 30 percent of the predictable variation of expected returns, using standard lagged information variables, is attributed to surplus consumption.

JEL Classification: G12

Suggested Citation

Li, Yuming, Expected Returns and Habit Persistence (June 23, 2000). Available at SSRN: https://ssrn.com/abstract=239817 or http://dx.doi.org/10.2139/ssrn.239817

Yuming Li (Contact Author)

California State University ( email )

School of Business Box 6848
Fullerton, CA 92834-9480
United States
714-278-2217 (Phone)
714-278-2161 (Fax)

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