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An iterated GMM procedure for estimating the Campbell-Cochrane habit formation model, with an application to Danish Stock and bond returns

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  • Tom Engsted

    (CREATES and School of Economics and Management, University of Aarhus, Aarhus C., Denmark)

  • Stig V. Møller

    (CREATES and Aarhus School of Business, University of Aarhus, Aarhus V., Denmark)

Abstract

We suggest an iterated GMM approach to estimate and test the consumption based habit persistence model of Campbell and Cochrane, and we apply the approach on annual and quarterly Danish stock and bond returns. For comparative purposes we also estimate and test the standard constant relative risk-aversion (CRRA) model. In addition, we compare the pricing errors of the different models using Hansen and Jagannathan's specification error measure. The main result is that for Denmark the Campbell-Cochrane model does not seem to perform markedly better than the CRRA model. For the long annual sample period covering more than 80 years there is absolutely no evidence of superior performance of the Campbell-Cochrane model. For the shorter and more recent quarterly data over a 20-30 year period, there is some evidence of counter-cyclical time-variation in the degree of risk-aversion, in accordance with the Campbell-Cochrane model, but the model does not produce lower pricing errors or more plausible parameter estimates than the CRRA model. Copyright © 2009 John Wiley & Sons, Ltd.

Suggested Citation

  • Tom Engsted & Stig V. Møller, 2010. "An iterated GMM procedure for estimating the Campbell-Cochrane habit formation model, with an application to Danish Stock and bond returns," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(3), pages 213-227.
    • Handle: RePEc:ijf:ijfiec:v:15:y:2010:i:3:p:213-227
    DOI: 10.1002/ijfe.389
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    Cited by:

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    3. Kakeu, Johnson & Nguimkeu, Pierre, 2017. "Habit formation and exhaustible resource risk-pricing," Energy Economics, Elsevier, vol. 64(C), pages 1-12.

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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