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An Empirical Investigation of Consumption-Based Asset Pricing Models with Stochastic Habit Formation

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  • Qiang Dai

    (Braid Capital Pte Ltd, Singapore)

  • Olesya V. Grishchenko

    () (Board of Governors of the Federal Reserve System, Washington, DC 20551, USA)

Abstract

We econometrically estimate and test a consumption-based asset pricing model with stochastic internal habit. The model departs from existing deterministic internal habit models by introducing shocks to the coefficients in the distributed lag specification of consumption habit and consequently an additional shock to the marginal rate of substitution. Habit shocks are persistent and provide an additional source of time variation in expected returns. Using returns on aggregate market and Treasury bond portfolios, we show that stochastic internal habit models provide a better explanation of time variation in expected returns than models with either deterministic habit or stochastic external habit.

Suggested Citation

  • Qiang Dai & Olesya V. Grishchenko, 2014. "An Empirical Investigation of Consumption-Based Asset Pricing Models with Stochastic Habit Formation," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 4(01), pages 1-34.
  • Handle: RePEc:wsi:qjfxxx:v:04:y:2014:i:01:n:s2010139214500050
    DOI: 10.1142/S2010139214500050
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    References listed on IDEAS

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    1. Eduard Dubin & Olesya V. Grishchenko & Vasily Kartashov, 2012. "Habit formation heterogeneity: Implications for aggregate asset pricing," Finance and Economics Discussion Series 2012-07, Board of Governors of the Federal Reserve System (U.S.), revised 2012.

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