Campbell and Cochrane meet Melino and Yang: Reverse engineering the surplus ratio in a Mehra–Prescott economy

Jim Dolmas

The North American Journal of Economics and Finance, 2017, vol. 40, issue C, 55-62

Abstract: The well-known habit model of Campbell and Cochrane (1999) specifies a process for the ‘surplus ratio’—the excess of consumption over habit, relative to consumption—rather than an evolution for the habit stock. This paper shows that Campbell–Cochrane preferences can be accommodated in a Markov chain framework à la Mehra and Prescott (1985) and mapped into an equivalent state-dependent form of the sort studied by Melino and Yang (2003). The equivalence sheds light on the workings of Campbell–Cochrane preferences and the plausibility of upcounting in Melino and Yang’s framework. The result may also have some pedagogical value.

Keywords: Habit; Asset returns; Stochastic discount factor; State-dependent preferences (search for similar items in EconPapers)
JEL-codes: E44 G12 (search for similar items in EconPapers)
Date: 2017
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Working Paper: Campbell and Cochrane meet Melino and Yang: reverse engineering the surplus ratio in a Mehra-Prescott economy (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:40:y:2017:i:c:p:55-62

DOI: 10.1016/j.najef.2017.01.006

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