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An iterated GMM procedure for estimating the Campbell-Cochrane habit formation model, with an application to Danish Stock and bond returns

  • Tom Engsted

    (CREATES and School of Economics and Management, University of Aarhus, Aarhus C., Denmark)

  • Stig V. M�ller

    (CREATES and Aarhus School of Business, University of Aarhus, Aarhus V., Denmark)

We suggest an iterated GMM approach to estimate and test the consumption based habit persistence model of Campbell and Cochrane, and we apply the approach on annual and quarterly Danish stock and bond returns. For comparative purposes we also estimate and test the standard constant relative risk-aversion (CRRA) model. In addition, we compare the pricing errors of the different models using Hansen and Jagannathan's specification error measure. The main result is that for Denmark the Campbell-Cochrane model does not seem to perform markedly better than the CRRA model. For the long annual sample period covering more than 80 years there is absolutely no evidence of superior performance of the Campbell-Cochrane model. For the shorter and more recent quarterly data over a 20-30 year period, there is some evidence of counter-cyclical time-variation in the degree of risk-aversion, in accordance with the Campbell-Cochrane model, but the model does not produce lower pricing errors or more plausible parameter estimates than the CRRA model. Copyright © 2009 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/ijfe.389
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Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 15 (2010)
Issue (Month): 3 ()
Pages: 213-227

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Handle: RePEc:ijf:ijfiec:v:15:y:2010:i:3:p:213-227
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  1. Tom Engsted & Stuart Hyde & Stig V. Møller, 2007. "Habit Formation, Surplus Consumption and Return Predictability: International Evidence," CREATES Research Papers 2007-31, School of Economics and Management, University of Aarhus.
  2. Stig V. Møller, 2007. "Habit persistence: Explaining cross sectional variation in returns and time-varying expected returns," CREATES Research Papers 2007-07, School of Economics and Management, University of Aarhus.
  3. Stuart Hyde & Keith Cuthbertson & Dirk Nitzsche, 2005. "Resuscitating the C-CAPM: empirical evidence from France and Germany," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 10(4), pages 337-357.
  4. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  5. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing Specification Errors in Stochastic Discount Factor Models," NBER Technical Working Papers 0153, National Bureau of Economic Research, Inc.
  6. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  7. Engsted, Tom, 2002. " Measures of Fit for Rational Expectations Models," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 301-55, July.
  8. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887 Elsevier.
  9. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  10. Stuart Hyde & Mohamed Sherif, 2005. "Consumption Asset Pricing Models: Evidence From The Uk," Manchester School, University of Manchester, vol. 73(3), pages 343-363, 06.
  11. Hansen, Lars Peter & Heaton, John & Luttmer, Erzo G J, 1995. "Econometric Evaluation of Asset Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 8(2), pages 237-74.
  12. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
  13. Li, Yuming & Zhong, Maosen, 2005. "Consumption habit and international stock returns," Journal of Banking & Finance, Elsevier, vol. 29(3), pages 579-601, March.
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