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

Qiang Dai and Olesya Grishchenko
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Qiang Dai: Braid Capital Pte Ltd, Singapore

Quarterly Journal of Finance (QJF), 2014, vol. 04, issue 01, 1-34

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.

Keywords: Consumption-based asset pricing models; external habit; internal habit; deterministic habit; stochastic habit; preference shocks; aggregate equity and bond returns (search for similar items in EconPapers)
Date: 2014
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Working Paper: An empirical investigation of consumption-based asset pricing models with stochastic habit formation (2011)
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DOI: 10.1142/S2010139214500050

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