Asset Prices Under Habit Formation and Reference-Dependent Preferences
43 Pages Posted: 16 Apr 2006 Last revised: 17 Jun 2009
Date Written: May 7, 2007
This article explains the high level and the countercyclical variation of the equity premium in a consumption-based asset pricing model with low large-scale risk aversion. Investors have gain-loss utility over consumption relative to slowly time-varying habit. Stocks deliver low returns in recessions when consumption falls below habit; investors therefore require a high premium for holding stocks. The model's conditional moment restrictions are tested on consumption and asset returns data. The empirical estimate of large-scale risk aversion is low, whereas the estimate of loss aversion agrees with prior experimental evidence.
Keywords: Asset pricing, Consumption, Equity premium, Habit formation, Loss aversion
JEL Classification: E21, G12
Suggested Citation: Suggested Citation