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Habit persistence: Explaining cross sectional variation in returns and time-varying expected returns

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  • Stig V. Møller

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

Abstract

This paper finds empirical support for the habit persistence model of Camp- bell and Cochrane (1999) along both cross sectional and time-series dimensions of the US stock market. GMM estimations show that the model is able to explain a substantial part of the cross sectional variation of returns on the 25 Fama and French value and size portfolios over the period 1932-2003, although it has difficul- ties in fully explaining the value premium, and some of the implied risk free rates are strongly negative. In addition, the model accounts for time-varying expected returns on stocks. Forecasting regressions show that the estimated surplus con- sumption ratio has strong forecasting power for future real stock returns and holds additional explanatory power relative to traditional financial forecasting variables such as the dividend yield. We also document that the Campbell-Cochrane model is particularly successful up to 1991. Including data from the 1990s reduces some- what the fit of the model.

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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2007-07.

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Length: 29
Date of creation: 15 May 2007
Date of revision:
Handle: RePEc:aah:create:2007-07

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Web page: http://www.econ.au.dk/afn/

Related research

Keywords: Campbell-Cochrane model; 25 Fama-French portfolios; GMM; return predictability by surplus-consumption ratio;

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References

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  1. Adrien Verdelhan, 2005. "A Habit-Based Explanation of the Exchange Rate Risk Premium," Boston University - Department of Economics - Working Papers Series WP2005-032, Boston University - Department of Economics.
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  5. Thomas Tallarini & Harold Zhang, . "External Habit and the Cyclicality of Expected Stock Returns," GSIA Working Papers 1997-26, Carnegie Mellon University, Tepper School of Business.
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  7. Li, Yuming, 2005. "The Wealth-Consumption Ratio and the Consumption-Habit Ratio," Journal of Business & Economic Statistics, American Statistical Association, vol. 23, pages 226-241, April.
  8. 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.
  9. Jessica Wachter & Martin Lettau, 2005. "Why is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium," 2005 Meeting Papers 302, Society for Economic Dynamics.
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  34. 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.
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Citations

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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. Bach, Christian & Møller, Stig V., 2011. "Habit-based asset pricing with limited participation consumption," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 2891-2901, November.
  3. Tom Engsted & Stig V. M�ller, 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.
  4. 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.
  5. Tom Engsted & Stuart Hyde & Stig V. Møller, 2007. "Habit Formation, Surplus Consumption and Return Predictability: International Evidence," CREATES Research Papers 2007-31, School of Economics and Management, University of Aarhus.
  6. Gómez Manuel A., 2010. "Endogenous Growth, Habit Formation and Convergence Speed," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-32, January.

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