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Consumption-Based Asset Pricing, Part 2: Habit Formation, Conditional Risks, Long-Run Risks, and Rare Disasters

Author

Listed:
  • Douglas T. Breeden

    (Fuqua School of Business, Duke University, Durham, North Carolina 27708)

  • Robert H. Litzenberger

    (The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104)

  • Tingyan Jia

    (Graduate School of Business, Stanford University, Stanford, California 94305)

Abstract

Following Part 1 of this article, which reviews late-1970s to 1990s classic derivations and tests of the consumption capital asset pricing model, here in Part 2 we review more recent developments, some of which are based on utility functions with non-time-separable preferences. Important second-generation consumption-based asset pricing advances are also reviewed, including models with habit formation and long-run risk. These models give large cyclical changes in relative risk aversion and risk premiums as well as lagged impacts of aggregate consumption changes on risk premiums. We review asset pricing with rare disasters and models focused on consumer spending on durables and real estate, as well as the fraction of spending financed by labor income. The second-generation models discussed have more free parameters and fit the empirical data better than did the first-generation consumption-based asset pricing models.

Suggested Citation

  • Douglas T. Breeden & Robert H. Litzenberger & Tingyan Jia, 2015. "Consumption-Based Asset Pricing, Part 2: Habit Formation, Conditional Risks, Long-Run Risks, and Rare Disasters," Annual Review of Financial Economics, Annual Reviews, vol. 7(1), pages 85-131, December.
    • Handle: RePEc:anr:refeco:v:7:y:2015:p:85-131
    DOI: 10.1146/annurev-financial-091115-014822
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    Citations

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    Cited by:

    1. Djeutem Edouard & Nguimkeu Pierre, 2020. "Robust learning in the foreign exchange market," The B.E. Journal of Macroeconomics, De Gruyter, vol. 20(1), pages 1-14, January.
    2. Liu, Yan, 2021. "Index option returns and generalized entropy bounds," Journal of Financial Economics, Elsevier, vol. 139(3), pages 1015-1036.
    3. Òscar Jordà & Moritz Schularick & Alan M. Taylor, 2019. "The Total Risk Premium Puzzle," NBER Working Papers 25653, National Bureau of Economic Research, Inc.
    4. Calvet, Laurent-Emmanuel & Grandmont, Jean-Michel & Lemaire, Isabelle, 2018. "Aggregation of heterogenous beliefs, asset pricing, and risk sharing in complete financial markets," Research in Economics, Elsevier, vol. 72(1), pages 117-146.

    More about this item

    Keywords

    asset pricing; CCAPM; consumption; habit formation; long-run risk; nonseparable preferences; rare disasters;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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