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Habit Formation, Surplus Consumption and Return Predictability: International Evidence

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Author Info
Tom Engsted
Stuart Hyde
Stig V. Møller () (School of Economics and Management, University of Aarhus, Denmark and CREATES)

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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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Publisher 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
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Handle: RePEc:aah:create:2007-31

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

Find related papers by JEL classification:
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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