By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior
John Campbell () and
John Cochrane ()
No 4995, NBER Working Papers from National Bureau of Economic Research, Inc
We present a consumption-based model that explains the procyclical variation of stock prices, the long-horizon predictability of excess stock returns, and the countercyclical variation of stock market volatility. Our model has an i.i.d. consumption growth driving process, and adds a slow-moving external habit to the standard power utility function. The latter feature produces cyclical variation in risk aversion, and hence in the prices of risky assets. Our model also predicts many of the difficulties that beset the standard power utility model, including Euler equation rejections, no correlation between mean consumption growth and interest rates, very high estimates of risk aversion, and pricing errors that are larger than those of the static CAPM. Our model captures much of the history of stock prices, given only consumption data. Since our model captures the equity premium, it implies that fluctuations have important welfare costs. Unlike many habit-persistence models, our model does not necessarily produce cyclical variation in the risk free interest rate, nor does it produce an extremely skewed distribution or negative realizations of the marginal rate of substitution.
Note: AP EFG
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (88) Track citations by RSS feed
Published as Journal of Political Economy, Vol.107 (April 1999): 205-251.
Downloads: (external link)
Journal Article: Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior (1999)
Working Paper: By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior (1999)
Working Paper: By force of habit: a consumption-based explanation of aggregate stock market behavior (1994)
Working Paper: By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior (1994)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:4995
Ordering information: This working paper can be ordered from
Access Statistics for this paper
More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().