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Can habit formation under complete market integration explain the cross-section of international equity risk premia?

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  • Auer, Benjamin R.
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    Abstract

    In this article, we analyse whether the prominent habit formation model of Campbell and Cochrane (1999) can explain the cross-section of the G7 equity risk premia when formulated under the assumption of complete capital market integration. We test the conditional covariance representation of the model using a combined GARCH and GMM approach in the spirit of Bali (2008) and find that in comparison to the CAPM and the standard power utility CCAPM the habit model has superior explanatory power. It explains more than 90% of the cross-sectional variation in risk premia. Overall, our findings suggest that global consumption-based recession indicators and not returns of reference portfolios are key risk factors driving equity risk premia.

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    Bibliographic Info

    Article provided by Elsevier in its journal Review of Financial Economics.

    Volume (Year): 22 (2013)
    Issue (Month): 2 ()
    Pages: 61-67

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    Handle: RePEc:eee:revfin:v:22:y:2013:i:2:p:61-67

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    Web page: http://www.elsevier.com/locate/inca/620170

    Related research

    Keywords: Bivariate GARCH; CCAPM; Market integration; Conditional covariance; Habit formation;

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