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External Habit and the Cyclicality of Expected Stock Returns

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  • Thomas D. Tallarini, Jr.

    (Federal Reserve Board)

  • Harold H. Zhang

    (Kennan-Flager Business School, University of North Carolina at Chapel Hill)

Abstract

We estimate an equilibrium asset pricing model in which agents' preferences have an unobserved external habit using the efficient method of moments (EMM). Given the estimated structural parameters, we examine the cyclical behavior of expected stock returns in the model. We find that the estimated structural parameters imply countercyclical expected stock returns as documented in existing empirical studies. The model, however, is still rejected at the 1% level. Detailed examination of the moment conditions in our estimation indicates that the model performs reasonably well in matching the mean of returns, but it fails to capture the higher-order moments.

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Bibliographic Info

Article provided by University of Chicago Press in its journal Journal of Business.

Volume (Year): 78 (2005)
Issue (Month): 3 (May)
Pages: 1023-1048

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Handle: RePEc:ucp:jnlbus:v:78:y:2005:i:3:p:1023-1048

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