Does Intrinsic Habit Formation Actually Resolve the Equity Premium Puzzle?

David Chapman ()

Review of Economic Dynamics, 2002, vol. 5, issue 3, 618-645

Abstract: Constantinides (1990) describes a simple model of intrinsic habit formation that appears to resolve the "equity premium puzzle" of Mehra and Prescott (1985). This finding is particularly important, since it has motivated a broader consideration of the implications of habit formation preferences in dynamic equilibrium models. However, consumption growth actually behaves very differently pre- and post-1948, and the explanatory power of the habit formation model is driven by the pre-1948 data. Using data from 1949 to 2000, constructed in a manner comparable to Mehra and Prescott (1985), I demonstrate that intrinsic habit cannot rationalize the unconditional moments of discrete consumption and real asset returns with values of the risk aversion coefficient that are less than four times larger than the values found in Constantinides (1990), for any feasible calibration of the model. (Copyright: Elsevier)

JEL-codes: E21 G12 (search for similar items in EconPapers)
Date: 2002
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Citations: View citations in EconPapers (6)

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DOI: 10.1006/redy.2001.0155

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