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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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  • David A. Chapman, 2002. "Does Intrinsic Habit Formation Actually Resolve the Equity Premium Puzzle?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(3), pages 618-645, July.
    • Handle: RePEc:red:issued:v:5:y:2002:i:3:p:618-645
    DOI: 10.1006/redy.2001.0155
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    Cited by:

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    2. Budria, Santiago & Díaz, Antonia, 2006. "Term premium and equity premium in economies with habit formation," UC3M Working papers. Economics we065522, Universidad Carlos III de Madrid. Departamento de Economía.
    3. René Garcia & Richard Luger, 2012. "Risk aversion, intertemporal substitution, and the term structure of interest rates," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 27(6), pages 1013-1036, September.
    4. Collard, Fabrice & Fève, Patrick & Ghattassi, Imen, 2003. "Solving Asset Pricing Models with Habit Persistence," IDEI Working Papers 245, Institut d'Économie Industrielle (IDEI), Toulouse.
    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, vol. 3(2), pages 193-212, March.

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    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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