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Do Consumption Habit and Income Difference Eliminate the Risk Premium in Chinese Capital Market?

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  • Yajie Wang
  • Zhongyuan Geng
  • Wuting Yang

Abstract

This paper explores the effects of Chinese urban residents' consumption habits with income differences on financial asset pricing over the period 1991–2016. With the use of generalized method of moments estimation, the results reveal that the specific values of habit‐formation parameter k eliminate the high‐risk premium puzzle in the standard consumption‐based Capital Asset Pricing Model to a certain extent based on the data of consumption of urban residents at different income levels, the rate of total stock market return, and the risk‐free asset return rate. Moreover, the empirical tests also uncover income differences that cannot explain the risk premium themselves but do reveal that people with different income levels have different attitudes toward risks.

Suggested Citation

  • Yajie Wang & Zhongyuan Geng & Wuting Yang, 2019. "Do Consumption Habit and Income Difference Eliminate the Risk Premium in Chinese Capital Market?," The Developing Economies, Institute of Developing Economies, vol. 57(2), pages 99-124, June.
    • Handle: RePEc:bla:deveco:v:57:y:2019:i:2:p:99-124
    DOI: 10.1111/deve.12195
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