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Does Intrinsic Habit Formation Actually Resolve the Equity Premium Puzzle?

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  • David A. Chapman

    (University of Texas, Austin)

Abstract

Constantinides (1990) describes a simple model of intrinsic habit formation that appears to resolve the "equity premium puzzle" of Mehra and Prescott (1985). This finding is particularly important, since it has motivated a broader consideration of the implications of habit formation preferences in dynamic equilibrium models. However, consumption growth actually behaves very differently pre- and post-1948, and the explanatory power of the habit formation model is driven by the pre-1948 data. Using data from 1949 to 2000, constructed in a manner comparable to Mehra and Prescott (1985), I demonstrate that intrinsic habit cannot rationalize the unconditional moments of discrete consumption and real asset returns with values of the risk aversion coefficient that are less than four times larger than the values found in Constantinides (1990), for any feasible calibration of the model. (Copyright: Elsevier)

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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 5 (2002)
Issue (Month): 3 (July)
Pages: 618-645

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Handle: RePEc:red:issued:v:5:y:2002:i:3:p:618-645

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  6. Otrok, C. & Ravikumar, B. & Whiteman, C., 1998. "Habit Formation: A Resolution of the Equity Premium Puzzle?," Working Papers, University of Iowa, Department of Economics 98-04, University of Iowa, Department of Economics.
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  16. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(3), pages 519-43, June.
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Citations

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Cited by:
  1. René Garcia & Richard Luger, 2012. "Risk aversion, intertemporal substitution, and the term structure of interest rates," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 27(6), pages 1013-1036, 09.
  2. Arjen Siegmann, 2003. "Shortfall allowed: loss aversion and habit formation," WO Research Memoranda (discontinued), Netherlands Central Bank, Research Department 741, Netherlands Central Bank, Research Department.
  3. Collard, Fabrice & Fève, Patrick & Ghattassi, Imen, 2003. "Solving Asset Pricing Models with Habit Persistence," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 245, Institut d'Économie Industrielle (IDEI), Toulouse.
  4. Santiago Budria & Antonia Diaz, 2006. "Term Premium And Equity Premium In Economies With Habit Formation," Economics Working Papers we065522, Universidad Carlos III, Departamento de Economía.
  5. Santiago Budría & Antonia Díaz, 2006. "Term and Equity Premium in Economies with Habit Formation," Working Papers 2006-23, FEDEA.
  6. Stefano Athanasoulis & Oren Sussman, 2007. "Habit formation and the equity–premium puzzle: a skeptical view," Annals of Finance, Springer, Springer, vol. 3(2), pages 193-212, March.
  7. Mary C. Daly & Daniel J. Wilson, 2006. "Keeping up with the Joneses and staying ahead of the Smiths: evidence from suicide data," Working Paper Series, Federal Reserve Bank of San Francisco 2006-12, Federal Reserve Bank of San Francisco.

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