Testing Habits in an Asset Pricing Model

41 Pages Posted: 16 Mar 2012

See all articles by Stefano d'Addona

Stefano d'Addona

University of Roma Tre

Melisso Boschi

Centre for Applied Macroeconomic Analysis (CAMA)

Aditya Goenka

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: March 3, 2012

Abstract

We develop an asset pricing model with external habit formation. The model predicts that the effect of consumption shocks on the equity premium depends on the business cycle. We test this empirical implication using a VAR model of the U.S. postwar economy whose parameters are estimated conditioning on Markov-switching regimes that shift according to the business cycle phases. The results show that the response of the equity premium to consumption shocks is insignificantly different across the business cycle phases of the economy. We interpret this result as evidence against the habit formation hypothesis.

Keywords: Habit formation, Equity premium, Business cycles, Markov-switching models, Regime-dependent impulse response functions

JEL Classification: E21, E32, E44, G11, G12

Suggested Citation

d'Addona, Stefano and Boschi, Melisso and Goenka, Aditya, Testing Habits in an Asset Pricing Model (March 3, 2012). Available at SSRN: https://ssrn.com/abstract=2023182 or http://dx.doi.org/10.2139/ssrn.2023182

Stefano D'Addona (Contact Author)

University of Roma Tre ( email )

Via Chiabrera, 199
Rome, 00145
Italy

Melisso Boschi

Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

Aditya Goenka

affiliation not provided to SSRN ( email )

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