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Habit Formation, Surplus Consumption and Return Predictability: International Evidence

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  • Tom Engsted
  • Stuart Hyde
  • Stig V. Møller

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

Abstract

On an international post World War II dataset, we use an iterated GMM pro- cedure to estimate and test the Campbell-Cochrane (1999) habit formation model. In addition, we analyze the predictive power of the surplus consumption ratio for future asset returns. We find that, although there are important cross-country differences, for the majority of countries in our sample the model gets empirical support in a variety of diffrent dimensions, including reasonable estimates of risk- free rates, and the model dominates the time-separable power utility model in terms of pricing errors. Further, for the majority of countries the surplus consumption ratio captures time-variation in expected returns. Together with the price-dividend ratio, the surplus consumption ratio contains significant information about future stock returns, also during the 1990s. Finally, in most countries the surplus con- sumption ratio is also a powerful predictor of future bond returns.

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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 2007-31.

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Length: 31
Date of creation: 30 Oct 2007
Date of revision:
Handle: RePEc:aah:create:2007-31

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

Related research

Keywords: Habit formation; Campbell-Cochrane model; surplus consumption ratio; GMM estimation; pricing errors; return predictability;

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References

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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. Bin Li & Benjamin Liu & Eduardo Roca, 2010. "An Empirical Investigation of Consumption CAPMs in the Australian Market," Discussion Papers in Finance finance:201011, Griffith University, Department of Accounting, Finance and Economics.
  3. Tom Engsted & Stig V. Møller & Magnus Sander, 2013. "Bond return predictability in expansions and recessions," CREATES Research Papers 2013-13, School of Economics and Management, University of Aarhus.
  4. Tom Engsted & Stig V. Møller, 2008. "An iterated GMM procedure for estimating the Campbell-Cochrane habit formation model, with an application to Danish stock and bond returns," CREATES Research Papers 2008-12, School of Economics and Management, University of Aarhus.
  5. 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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