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An Empirical Investigation of the Campbell‐Cochrane Habit Utility Model

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  • Edward R. Lawrence
  • John Geppert
  • Arun J. Prakash

Abstract

This paper tests whether the Campbell and Cochrane (1999) habit utility model generates a valid stochastic discount factor for the 25 Fama‐French size/book‐to‐market and size/momentum sorted portfolios. Campbell and Cochrane (1999) derive a consumption based habit utility asset pricing model and calibrate it to aggregate US stock market data. However, they do not test whether their model is consistent with a larger cross section of asset returns. We test their model using the methodology of Hansen and Jagannathan (1991) and Burnside (1994). In contrast to previous studies, we find that for reasonable parameter values, the model's stochastic discount factor is inside the Hansen‐Jagannathan bounds and therefore satisfies the necessary conditions for a valid stochastic discount factor. We trace the difference between our results and previous studies to the method used to estimate the model's parameters and the parameter values themselves.

Suggested Citation

  • Edward R. Lawrence & John Geppert & Arun J. Prakash, 2009. "An Empirical Investigation of the Campbell‐Cochrane Habit Utility Model," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(5‐6), pages 774-791, June.
    • Handle: RePEc:bla:jbfnac:v:36:y:2009:i:5-6:p:774-791
    DOI: 10.1111/j.1468-5957.2009.02134.x
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    References listed on IDEAS

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    1. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-262, April.
    2. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    3. Thomas D. Tallarini, Jr. & Harold H. Zhang, 2005. "External Habit and the Cyclicality of Expected Stock Returns," The Journal of Business, University of Chicago Press, vol. 78(3), pages 1023-1048, May.
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    5. Jonathan Fletcher & Patricia Ntozi-Obwale, 2008. "Arbitrage Bounds and UK Unit Trust Performance," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(3-4), pages 580-600.
    6. University of Chicago & Jose L. Fillat, 2008. "Housing as a Measure for the Long Run Risk in Asset Pricing," 2008 Meeting Papers 483, Society for Economic Dynamics.
    7. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    8. Jonathan Fletcher & Patricia Ntozi‐Obwale, 2008. "Arbitrage Bounds and UK Unit Trust Performance," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 35(3‐4), pages 580-600, April.
    9. Gregory, Allan W. & Smith, Gregor W., 1992. "Sampling variability in Hansen-Jagannathan bounds," Economics Letters, Elsevier, vol. 38(3), pages 263-267, March.
    10. Burnside, Craig, 1994. "Hansen-Jagannathan Bounds as Classical Tests of Asset-Pricing Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(1), pages 57-79, January.
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