Habit Formation, Surplus Consumption and Return Predictability: International Evidence

Tom Engsted (), Stuart Hyde and Stig V. Møller ()
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Stig V. Møller: School of Economics and Management, University of Aarhus, Denmark and CREATES, Postal: 8000 Aarhus C, Denmark

CREATES Research Papers from School of Economics and Management, University of Aarhus

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.

Keywords: Habit formation; Campbell-Cochrane model; surplus consumption ratio; GMM estimation; pricing errors; return predictability (search for similar items in EconPapers)
JEL-codes: E21 G12 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2007-10-30
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Persistent link: http://EconPapers.repec.org/RePEc:aah:create:2007-31

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