[go: up one dir, main page]
IDEAS home Printed from https://ideas.repec.org/p/bir/birmec/21-11.html
   My bibliography  Save this paper

Testing external habits in an asset pricing model

Author

Listed:
  • Melisso Boschi

    (Senate of the Republic of Italy)

  • Stefano d'Addona

    (University of Rome 3)

  • Aditya Goenka

    (University of Birmingham)

Abstract
A class of asset pricing models with external habit formation imply a nonlinear relationship between the counter-cyclical equity premium and the surplus consumption over the business cycle. The effect of a shock to surplus consumption on the equity premium will be asymmetric in a boom versus a recession. We test this using a novel approach to the estimation of a time-varying VAR model of the U.S. postwar economy where parameters are conditional on Markov-switching regimes associated to the business cycle phases. We estimate the regime-dependent impulse response functions and show that the equity premium increases following a negative shock to the surplus consumption either in boom or in recession. The response in recession is significantly larger than in boom. These results provide evidence in favor of the external habit formation hypothesis.

Suggested Citation

  • Melisso Boschi & Stefano d'Addona & Aditya Goenka, 2021. "Testing external habits in an asset pricing model," Discussion Papers 21-11, Department of Economics, University of Birmingham.
    • Handle: RePEc:bir:birmec:21-11
    as

    Download full text from publisher

    File URL: https://repec.cal.bham.ac.uk/pdf/21-11.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
    2. Cecchetti, Stephen G. & Lam, Pok-sang & Mark, Nelson C., 1993. "The equity premium and the risk-free rate : Matching the moments," Journal of Monetary Economics, Elsevier, vol. 31(1), pages 21-45, February.
    3. Boschi, Melisso & Goenka, Aditya, 2012. "Relative risk aversion and the transmission of financial crises," Journal of Economic Dynamics and Control, Elsevier, vol. 36(1), pages 85-99.
    4. Ehrmann, Michael & Ellison, Martin & Valla, Natacha, 2003. "Regime-dependent impulse response functions in a Markov-switching vector autoregression model," Economics Letters, Elsevier, vol. 78(3), pages 295-299, March.
    5. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
    6. John Campbell & Angus Deaton, 1989. "Why is Consumption So Smooth?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 56(3), pages 357-373.
    7. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-286, April.
    8. Dunn, Kenneth B. & Singleton, Kenneth J., 1986. "Modeling the term structure of interest rates under non-separable utility and durability of goods," Journal of Financial Economics, Elsevier, vol. 17(1), pages 27-55, September.
    9. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," The Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-386.
    10. Xiaohong Chen & Sydney C. Ludvigson, 2009. "Land of addicts? an empirical investigation of habit-based asset pricing models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(7), pages 1057-1093.
    11. repec:bla:revinw:v:48:y:2002:i:2:p:217-33 is not listed on IDEAS
    12. Carroll, Christopher D. & Weil, David N., 1994. "Saving and growth: a reinterpretation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 40(1), pages 133-192, June.
    13. Braun, Phillip A. & Constantinides, George M. & Ferson, Wayne E., 1993. "Time nonseparability in aggregate consumption : International evidence," European Economic Review, Elsevier, vol. 37(5), pages 897-920, June.
    14. Philippe Weil, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 105(1), pages 29-42.
    15. Larry G. Epstein & Stanley E. Zin, 2013. "Substitution, risk aversion and the temporal behavior of consumption and asset returns: A theoretical framework," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 12, pages 207-239, World Scientific Publishing Co. Pte. Ltd..
    16. Stefano d'Addona & Ilaria Musumeci, 2012. "The British opt-out from the European Monetary Union: empirical evidence from monetary policy rules," CEIS Research Paper 225, Tor Vergata University, CEIS, revised 26 Mar 2012.
    17. Kwiatkowski, Denis & Phillips, Peter C. B. & Schmidt, Peter & Shin, Yongcheol, 1992. "Testing the null hypothesis of stationarity against the alternative of a unit root : How sure are we that economic time series have a unit root?," Journal of Econometrics, Elsevier, vol. 54(1-3), pages 159-178.
    18. Gruber, Joseph W., 2004. "A present value test of habits and the current account," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1495-1507, October.
    19. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-179, March.
    20. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
    21. Pesaran M.H. & Schuermann T. & Weiner S.M., 2004. "Modeling Regional Interdependencies Using a Global Error-Correcting Macroeconometric Model," Journal of Business & Economic Statistics, American Statistical Association, vol. 22, pages 129-162, April.
    22. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    23. repec:adr:anecst:y:1988:i:9:p:03 is not listed on IDEAS
    24. John Muellbauer, 1988. "Habits, Rationality and Myopia in the Life Cycle Consumption Function," Annals of Economics and Statistics, GENES, issue 9, pages 47-70.
    25. Thomas D. Tallarini, Jr. & Harold H. Zhang, 2005. "External Habit and the Cyclicality of Expected Stock Returns," The Journal of Business, University of Chicago Press, vol. 78(3), pages 1023-1048, May.
    26. Ferson, Wayne E. & Constantinides, George M., 1991. "Habit persistence and durability in aggregate consumption: Empirical tests," Journal of Financial Economics, Elsevier, vol. 29(2), pages 199-240, October.
    27. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
    28. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-543, June.
    29. Martin S. Eichenbaum & Lars Peter Hansen & Kenneth J. Singleton, 1988. "A Time Series Analysis of Representative Agent Models of Consumption and Leisure Choice Under Uncertainty," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 103(1), pages 51-78.
    30. Li, Yuming, 2001. "Expected Returns and Habit Persistence," The Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 861-899.
    31. Christensen, Bent Jesper & van der Wel, Michel, 2019. "An asset pricing approach to testing general term structure models," Journal of Financial Economics, Elsevier, vol. 134(1), pages 165-191.
    32. Karen E. Dynan, 2000. "Habit Formation in Consumer Preferences: Evidence from Panel Data," American Economic Review, American Economic Association, vol. 90(3), pages 391-406, June.
    33. Hussain, Syed M. & Malik, Samreen, 2016. "Asymmetric Effects of Exogenous Tax Changes," Journal of Economic Dynamics and Control, Elsevier, vol. 69(C), pages 268-300.
    34. J. S. Taylor & John Spriggs, 1989. "Effects of the Monetary Macro-economy on Canadian Agricultural Prices," Canadian Journal of Economics, Canadian Economics Association, vol. 22(2), pages 278-289, May.
    35. Karl Whelan, 2002. "A Guide To U.S. Chain Aggregated Nipa Data," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 48(2), pages 217-233, June.
    36. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
    37. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
    38. Abel, Andrew B., 1999. "Risk premia and term premia in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 43(1), pages 3-33, February.
    39. Korniotis, George M., 2010. "Estimating Panel Models With Internal and External Habit Formation," Journal of Business & Economic Statistics, American Statistical Association, vol. 28(1), pages 145-158.
    40. repec:acb:camaaa:2007-28 is not listed on IDEAS
    41. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, September.
    42. Heaton, John, 1993. "The Interaction between Time-Nonseparable Preferences and Time Aggregation," Econometrica, Econometric Society, vol. 61(2), pages 353-385, March.
    43. Sims, Christopher A & Stock, James H & Watson, Mark W, 1990. "Inference in Linear Time Series Models with Some Unit Roots," Econometrica, Econometric Society, vol. 58(1), pages 113-144, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Melisso Boschi & Stefano d'Addona, 2019. "The Stability of Tax Elasticities over the Business Cycle in European Countries," Fiscal Studies, John Wiley & Sons, vol. 40(2), pages 175-210, June.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Rob Alessie & Federica Teppa, 2010. "Saving and habit formation: evidence from Dutch panel data," Empirical Economics, Springer, vol. 38(2), pages 385-407, April.
    2. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887, Elsevier.
    3. Johdo, Wataru, 2009. "Habit persistence and stagnation," Economic Modelling, Elsevier, vol. 26(5), pages 1110-1114, September.
    4. Christopher D. Carroll & Jiri Slacalek & Martin Sommer, 2011. "International Evidence on Sticky Consumption Growth," The Review of Economics and Statistics, MIT Press, vol. 93(4), pages 1135-1145, November.
    5. Julian Thimme, 2017. "Intertemporal Substitution In Consumption: A Literature Review," Journal of Economic Surveys, Wiley Blackwell, vol. 31(1), pages 226-257, February.
    6. Eduard Dubin & Olesya V. Grishchenko & Vasily Kartashov, 2012. "Habit formation heterogeneity: Implications for aggregate asset pricing," Finance and Economics Discussion Series 2012-07, Board of Governors of the Federal Reserve System (U.S.).
    7. Xiaohong Chen & Sydney C. Ludvigson, 2009. "Land of addicts? an empirical investigation of habit-based asset pricing models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 24(7), pages 1057-1093.
    8. Jacobs Martin, 2016. "Accounting for Changing Tastes: Approaches to Explaining Unstable Individual Preferences," Review of Economics, De Gruyter, vol. 67(2), pages 121-183, August.
    9. Havranek, Tomas & Rusnak, Marek & Sokolova, Anna, 2017. "Habit formation in consumption: A meta-analysis," European Economic Review, Elsevier, vol. 95(C), pages 142-167.
    10. Engsted, Tom & Hyde, Stuart & Møller, Stig V., 2010. "Habit formation, surplus consumption and return predictability: International evidence," Journal of International Money and Finance, Elsevier, vol. 29(7), pages 1237-1255, November.
    11. Grishchenko, Olesya V., 2010. "Internal vs. external habit formation: The relative importance for asset pricing," Journal of Economics and Business, Elsevier, vol. 62(3), pages 176-194, May.
    12. Ludvigson, Sydney C., 2013. "Advances in Consumption-Based Asset Pricing: Empirical Tests," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 799-906, Elsevier.
    13. Wonnho Choi, 2018. "Consumption-based capital asset pricing models: issues and controversies," Review of Quantitative Finance and Accounting, Springer, vol. 50(1), pages 181-205, January.
    14. Gómez Manuel A., 2010. "Endogenous Growth, Habit Formation and Convergence Speed," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-32, January.
    15. Enrichetta Ravina, 2005. "Keeping Up with the Joneses: Evidence from Micro Data," 2005 Meeting Papers 557, Society for Economic Dynamics.
    16. Suresh M. Sundaresan, 2000. "Continuous‐Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, August.
    17. M. Fatih Guvenen, 2003. "A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?," RCER Working Papers 499, University of Rochester - Center for Economic Research (RCER).
    18. Reis Gomes, Fábio Augusto, 2020. "Evaluating a consumption function with precautionary savings and habit formation under a general income process," The Quarterly Review of Economics and Finance, Elsevier, vol. 76(C), pages 157-166.
    19. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, August.

    More about this item

    Keywords

    Habit formation; Equity premium; Business cycle; Markov-switching models; Time-varying VAR; Regime-dependent impulse response functions;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bir:birmec:21-11. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Oleksandr Talavera (email available below). General contact details of provider: https://edirc.repec.org/data/debhauk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.