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External Habit and the Cyclicality of Expected Stock Returns

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Abstract

We estimate an equilibrium asset pricing model in which agents' preferences have an unobserved external habit using the efficient method of moments (EMM). Given the estimated structural parameters, we examine the cyclical behavior of expected stock returns in the model. We find that the estimated structural parameters imply countercyclical expected stock returns as documented in existing empirical studies. The model, however, is still rejected at the 1% level. Detailed examination of the moment conditions in our estimation indicates that the model performs reasonably well in matching the mean of returns, but it fails to capture the higher-order moments.

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Paper provided by Carnegie Mellon University, Tepper School of Business in its series GSIA Working Papers with number 1997-26.

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Handle: RePEc:cmu:gsiawp:32

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Postal: Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213-3890
Web page: http://www.tepper.cmu.edu/

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References

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  28. Kandel, Shmuel & Stambaugh, Robert F, 1990. "Expectations and Volatility of Consumption and Asset Returns," Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 207-32.
  29. Ming Liu & Harold Zhang, 1996. "Specification Tests in the Efficient Method of Moments Framework with Application to the Stochastic Volatility Models," GSIA Working Papers 34, Carnegie Mellon University, Tepper School of Business.
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