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Habit Formation, Surplus Consumption and Return Predictability: International Evidence

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  • Tom Engsted
  • Stuart Hyde
  • Stig V. Møller

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

Abstract

On an international post World War II dataset, we use an iterated GMM pro- cedure to estimate and test the Campbell-Cochrane (1999) habit formation model. In addition, we analyze the predictive power of the surplus consumption ratio for future asset returns. We find that, although there are important cross-country differences, for the majority of countries in our sample the model gets empirical support in a variety of diffrent dimensions, including reasonable estimates of risk- free rates, and the model dominates the time-separable power utility model in terms of pricing errors. Further, for the majority of countries the surplus consumption ratio captures time-variation in expected returns. Together with the price-dividend ratio, the surplus consumption ratio contains significant information about future stock returns, also during the 1990s. Finally, in most countries the surplus con- sumption ratio is also a powerful predictor of future bond returns.

Suggested Citation

  • Tom Engsted & Stuart Hyde & Stig V. Møller, 2007. "Habit Formation, Surplus Consumption and Return Predictability: International Evidence," CREATES Research Papers 2007-31, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:create:2007-31
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    Citations

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    Cited by:

    1. Tom Engsted & Stig V. Møller, 2010. "An iterated GMM procedure for estimating the Campbell-Cochrane habit formation model, with an application to Danish Stock and bond returns," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(3), pages 213-227.
    2. Auer, Benjamin R., 2013. "Can habit formation under complete market integration explain the cross-section of international equity risk premia?," Review of Financial Economics, Elsevier, vol. 22(2), pages 61-67.
    3. Bin Li & Benjamin Liu & Eduardo Roca, 2010. "An Empirical Investigation of Consumption CAPMs in the Australian Market," Discussion Papers in Finance finance:201011, Griffith University, Department of Accounting, Finance and Economics.
    4. Hassan Shareef & Santhakumar Shijin, 2016. "Expectations Hypothesis and Term Structure of Interest Rates: An Evidence from Emerging Market," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 23(2), pages 137-152, June.
    5. Joachim Inkmann & Zhen Shi, 2015. "Parametric Portfolio Policies in the Surplus Consumption Ratio," International Review of Finance, International Review of Finance Ltd., vol. 15(2), pages 257-282, June.
    6. Tom Engsted & Stig V. Møller & Magnus Sander, 2013. "Bond return predictability in expansions and recessions," CREATES Research Papers 2013-13, Department of Economics and Business Economics, Aarhus University.
    7. Auer Benjamin R., 2012. "Lassen sich CAPM, HCAPM und CCAPM durch konsumbasierte zeitvariable Parameterspezifikation rehabilitieren? / Can Time-varying Parameter Specification Based on Consumption Variables Rehabilitate CAPM, ," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 232(5), pages 518-544, October.

    More about this item

    Keywords

    Habit formation; Campbell-Cochrane model; surplus consumption ratio; GMM estimation; pricing errors; return predictability;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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