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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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Author Info

  • Tom Engsted

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

  • Stig V. M�ller

    (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.

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File URL: http://hdl.handle.net/10.1002/ijfe.389
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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 15 (2010)
Issue (Month): 3 ()
Pages: 213-227

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Handle: RePEc:ijf:ijfiec:v:15:y:2010:i:3:p:213-227

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  1. John Y. Campbell, 2002. "Consumption-Based Asset Pricing," Harvard Institute of Economic Research Working Papers 1974, Harvard - Institute of Economic Research.
  2. Hansen, Lars Peter & Heaton, John & Luttmer, Erzo G J, 1995. "Econometric Evaluation of Asset Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 237-74.
  3. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing Specification Errors in Stochastic Discount Factor Models," NBER Technical Working Papers 0153, National Bureau of Economic Research, Inc.
  4. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  5. Li, Yuming & Zhong, Maosen, 2005. "Consumption habit and international stock returns," Journal of Banking & Finance, Elsevier, vol. 29(3), pages 579-601, March.
  6. Engsted, Tom & Hyde, Stuart & Møller, Stig V., 2010. "Habit formation, surplus consumption and return predictability: International evidence," Journal of International Money and Finance, Elsevier, vol. 29(7), pages 1237-1255, November.
  7. Engsted, Tom, 2002. " Measures of Fit for Rational Expectations Models," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 301-55, July.
  8. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  9. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  10. Stuart Hyde & Mohamed Sherif, 2005. "Consumption Asset Pricing Models: Evidence From The Uk," Manchester School, University of Manchester, vol. 73(3), pages 343-363, 06.
  11. Stuart Hyde & Keith Cuthbertson & Dirk Nitzsche, 2005. "Resuscitating the C-CAPM: empirical evidence from France and Germany," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 10(4), pages 337-357.
  12. Møller, Stig Vinther, 2008. "Habit persistence: Explaining cross-sectional variation in returns and time-varying expected returns," Finance Research Group Working Papers F-2008-04, University of Aarhus, Aarhus School of Business, Department of Business Studies.
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Cited by:
  1. Benjamin R. Auer, 2012. "Lassen sich CAPM, HCAPM und CCAPM durch konsumbasierte zeitvariable Parameterspezifikation rehabilitieren?," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), Justus-Liebig University Giessen, Department of Statistics and Economics, vol. 232(5), pages 518-544, September.
  2. Auer, Benjamin R., 2013. "Can habit formation under complete market integration explain the cross-section of international equity risk premia?," Review of Financial Economics, Elsevier, vol. 22(2), pages 61-67.

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