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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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Citations

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Cited by:
  1. 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, Elsevier, vol. 22(2), pages 61-67.
  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, 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, School of Economics and Management, University of Aarhus 2008-12, School of Economics and Management, University of Aarhus.
  4. 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, Justus-Liebig University Giessen, Department of Statistics and Economics, vol. 232(5), pages 518-544, September.
  5. Tom Engsted & Stig V. Møller & Magnus Sander, 2013. "Bond return predictability in expansions and recessions," CREATES Research Papers, School of Economics and Management, University of Aarhus 2013-13, School of Economics and Management, University of Aarhus.

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