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Habit-based Asset Pricing with Limited Participation Consumption

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  • Christian Bach

    ()
    (School of Economics and Management and CREATES)

  • Stig Vinther Møller

    ()
    (Finance Research Group, Aarhus School of Business and CREATES)

Abstract

We calibrate and estimate a consumption-based asset pricing model with habit formation using limited participation consumption data. Based on survey data of a representative sample of American households, we distinguish between assetholder and non-assetholder consumption, as well as the standard aggregate consumption series commonly used in the CCAPM literature. We show that assetholder consumption outperforms non-assetholder and aggregate consumption data in explaining bond returns, bond yields, and the volatility of bond yields. We further show that the high volatility of assetholder consumption enables the model to explain the equity premium puzzle and the risk-free rate puzzle simultaneously for a reasonable value of relative risk aversion.

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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 2010-46.

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Length: 35
Date of creation: 16 Jun 2010
Date of revision:
Handle: RePEc:aah:create:2010-46

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

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Keywords: CCAPM; Limited participation consumption data; Habit formation; Real term structure; Risk premium; GMM estimation;

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References

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  1. John H. Cochrane & Monika Piazzesi, 2002. "Bond Risk Premia," NBER Working Papers 9178, National Bureau of Economic Research, Inc.
  2. Jessica A. Wachter, 2005. "Solving Models with External Habit," NBER Working Papers 11559, National Bureau of Economic Research, Inc.
  3. Mankiw, N.G. & Zeldes, S.P., 1990. "The Consumption Of Stockholders And Non-Stockholders," Weiss Center Working Papers, Wharton School - Weiss Center for International Financial Research 23-90, Wharton School - Weiss Center for International Financial Research.
  4. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, Econometric Society, vol. 50(4), pages 1029-54, July.
  5. John Y. Campbell & John H. Cochrane, 1994. "By force of habit: a consumption-based explanation of aggregate stock market behavior," Working Papers 94-17, Federal Reserve Bank of Philadelphia.
  6. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 24(3), pages 401-421, November.
  7. Martin Lettau & Jessica Wachter, 2005. "Why is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium," NBER Working Papers 11144, National Bureau of Economic Research, Inc.
  8. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  9. Stig V. Møller, 2007. "Habit persistence: Explaining cross sectional variation in returns and time-varying expected returns," CREATES Research Papers, School of Economics and Management, University of Aarhus 2007-07, School of Economics and Management, University of Aarhus.
  10. Alon Brav & George M. Constantinides & Christopher C. Geczy, . "Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 23-99, Wharton School Rodney L. White Center for Financial Research.
  11. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, Elsevier, vol. 33(1), pages 3-56, February.
  12. Jonathan A. Parker, 2001. "The Consumption Risk of the Stock Market," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(2), pages 279-348.
  13. Christopher J. Malloy & Tobias J. Moskowitz & Annette Vissing-Jørgensen, 2009. "Long-Run Stockholder Consumption Risk and Asset Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 64(6), pages 2427-2479, December.
  14. Wachter, Jessica A., 2006. "A consumption-based model of the term structure of interest rates," Journal of Financial Economics, Elsevier, Elsevier, vol. 79(2), pages 365-399, February.
  15. Santos, Tano & Veronesi, Pietro, 2010. "Habit formation, the cross section of stock returns and the cash-flow risk puzzle," Journal of Financial Economics, Elsevier, Elsevier, vol. 98(2), pages 385-413, November.
  16. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 110(4), pages 825-853, August.
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