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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27305
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| Title: | Land of Addicts? An Empirical Investigation of Habit-Based Asset Pricing Models |
| Authors: | Chen, Xiaohong
Ludvigson, Sydney C. |
| Issue Date: | 18-Feb-2008 |
| Series/Report no.: | S-MF-04-09 |
| Abstract: | A popular explanation of aggregate stock market behavior suggests that
assets are priced as if there were a representative investor whose
utility is a power function of the difference between aggregate
consumption and a “habit” level, where the habit is some
function of lagged and (possibly) contemporaneous consumption. But
theory does not provide precise guidelines about the parametric
functional relationship between the habit and aggregate consumption.
This makes for- mal estimation and testing challenging; at the same
time, it raises an empirical question about the functional form of the
habit that best explains asset pricing data. This paper studies the
ability of a general class of habit-based asset pricing models to match
the conditional moment restrictions implied by asset pricing theory. Our
approach is to treat the functional form of the habit as unknown, and to
estimate it along with the rest of the model’s finite dimensional
parameters. This semiparametric approach allows us to empirically
evaluate a number of interesting hypotheses about the specification of
habit-based asset pricing models. Using stationary quarterly data on
consumption growth, assets returns and instruments, our empirical
results indicate that the estimated habit function is nonlinear, the
habit formation is internal, and the estimated time-preference parameter
and the power utility parameter are sensible. In addition, our estimated
habit function generates a positive stochastic discount factor (SDF)
proxy and performs well in explaining cross-sectional stock return data.
We find that an internal habit SDF proxy can explain a cross-section of
size and book-market sorted portfolio equity returns better than (i) the
Fama and French (1993) three-factor model, (ii) the Lettau and Ludvigson
(2001b) scaled consumption CAPM model, (iii) an external habit SDF
proxy, (iv) the classic CAPM, and (v) the classic consumption CAPM. |
| URI: | http://hdl.handle.net/2451/27305 |
| Appears in Collections: | Macro Finance
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