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A parsimonious macroeconomic model for asset pricing: Habit . . .
, 2003
"... In this paper we study the asset pricing implications of a parsimonious twoagent macroeconomic model with two key features: limited participation in the stock market and heterogeneity in the elasticity of intertemporal substitution. The parameter values for the model are taken from the business cyc ..."
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Cited by 145 (2 self)
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In this paper we study the asset pricing implications of a parsimonious twoagent macroeconomic model with two key features: limited participation in the stock market and heterogeneity in the elasticity of intertemporal substitution. The parameter values for the model are taken from the business cycle literature and are not calibrated to match any financial statistic. Yet, with a risk aversion of two, the model is able to explain a large number of asset pricing phenomena including all the facts matched by the external habit model of Campbell and Cochrane (1999). Examples in this list include a high equity premium and a low riskfree rate; a countercyclical risk premium, volatility and Sharpe ratio; predictable stock returns with coefficients and R2 values of longhorizon regressions matching their empirical counterparts, among others. In addition the model generates a riskfree rate with low volatility (5.7 percent annually) and with high persistence. We also show that the similarity of our results to those from an external habit model is not a coincidence: the model has a reduced form representation which is remarkably similar to Campbell and Cochrane’s framework for asset pricing. However,themacroeconomic implications of the two models are quite different, favoring the limited participation model. Moreover, we show that policy analysis yields dramatically different conclusions in each framework.
Empirical pricing kernels
, 2001
"... This paper investigates the empirical characteristics of investor risk aversion over equity return states by estimating a timevarying pricing kernel, which we call the empirical pricing kernel (EPK). We estimate the EPK on a monthly basis from 1991 to 1995, using S&P 500 index option data and a ..."
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Cited by 141 (6 self)
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This paper investigates the empirical characteristics of investor risk aversion over equity return states by estimating a timevarying pricing kernel, which we call the empirical pricing kernel (EPK). We estimate the EPK on a monthly basis from 1991 to 1995, using S&P 500 index option data and a stochastic volatility model for the S&P 500 return process. We find that the EPK exhibits countercyclical risk aversion over S&P 500 return states. We also find that hedging performance is significantly improved when we use hedge ratios based the EPK rather than a timeinvariant pricing kernel.
A ConsumptionBased Model of the Term Structure of Interest Rates
, 2004
"... This paper proposes a consumptionbased model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a timevarying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expec ..."
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Cited by 138 (9 self)
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This paper proposes a consumptionbased model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a timevarying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expected inflation. When calibrated to data on consumption, inflation, and the average level of bond yields, the model produces realistic volatility of bond yields and can explain key aspects of the expectations puzzle documented by Campbell and Shiller (1991) and Fama and Bliss (1987). When actual consumption and inflation data are fed into the model, the model is shown to account for many of the short and longrun fluctuations in the shortterm interest rate and the yield spread. At the same time, the model captures the high equity premium and
Asset pricing with distorted beliefs: Are equity returns too good to be true?, Working paper
, 1997
"... We study a Lucas asset pricing model that is standard in all respects, except that the representative agent’s subjective beliefs about endowment growth are distorted. Using constantrelativeriskaversion utility, with relative risk aversion coefficient below ten, and fluctuating beliefs that exhibi ..."
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Cited by 134 (1 self)
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We study a Lucas asset pricing model that is standard in all respects, except that the representative agent’s subjective beliefs about endowment growth are distorted. Using constantrelativeriskaversion utility, with relative risk aversion coefficient below ten, and fluctuating beliefs that exhibit pessimism over expansions and optimism over contractions, our model is able to match the first and second moments of the equity premium and risk–free rate, as well as the persistence and predictability of excess returns found in the data.
Asset Pricing with Heterogeneous Consumers and Limited Participation: Empirical Evidence
 JOURNAL OF POLITICAL ECONOMY
, 1999
"... The Euler equations of consumption are tested on the household consumption of nondurables and services, reconstructed from the CEX database. The estimated relative risk aversion coefficient of the representative household decreases, and the estimated unexplained mean equity premium decreases, as inf ..."
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Cited by 114 (10 self)
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The Euler equations of consumption are tested on the household consumption of nondurables and services, reconstructed from the CEX database. The estimated relative risk aversion coefficient of the representative household decreases, and the estimated unexplained mean equity premium decreases, as infra marginal asset holders are eliminated from the sample. These results provide evidence of limited capital market participation. The estimated unexplained mean equity premium decreases when the assumption of complete consumption insurance is relaxed. The estimated correlation between the equity premium and the crosssectional variance of the households' consumption growth is negative, as required, if the relaxation of market completeness is to contribute towards the explanation of the premium. The overall evidence from asset prices in favor of relaxing the assumption of complete consumption insurance is weak. An extensive Monte Carlo investigation highlights the relationship between the economic implications of limited participation and the resulting statistical properties of commonly used test statistics. The simulation results provide direct evidence relating observation error in consumption and the resulting smallsample properties of the test statistics.
Catching Up with the Joneses: Heterogeneous Preferences and the Dynamics of Asset Prices
, 2001
"... ..."
Can Habit Formation Be Reconciled with Business Cycle Facts?” Review of Economic Dynamics 3
, 2000
"... Many asset pricing puzzles can be explained when habit formation is added to standard preferences. We show that utility functions with a habit then gives rise to a puzzle of consumption volatility in place of the asset pricing puzzles when agents can choose consumption and labor optimally in respons ..."
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Cited by 99 (8 self)
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Many asset pricing puzzles can be explained when habit formation is added to standard preferences. We show that utility functions with a habit then gives rise to a puzzle of consumption volatility in place of the asset pricing puzzles when agents can choose consumption and labor optimally in response to more fundamental shocks. We show that the consumption reaction to technology shocks is too small by an order of magnitude when a utility includes a consumption habit. Moreover, once a habit in leisure is included, labor input is counterfactually smooth over the cycle. In the case of habits in both consumption and leisure, labor input is even countercyclical. Consumption continues to be too smooth. Journal of Economic
Prospect theory and asset prices
 Quarterly Journal of Economics
, 2001
"... We study asset prices in an economy where investors derive direct utility not only from consumption but also from fluctuations in the value of their financial wealth. They are loss averse over these fluctuations, and the degree of loss aversion depends on their prior investment performance. We find ..."
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Cited by 98 (2 self)
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We study asset prices in an economy where investors derive direct utility not only from consumption but also from fluctuations in the value of their financial wealth. They are loss averse over these fluctuations, and the degree of loss aversion depends on their prior investment performance. We find that our framework can help explain the high mean, excess volatility, and predictability of stock returns, as well as their low correlation with consumption growth. The design of our model is influenced by prospect theory and by experimental evidence on how prior outcomes affect risky choice. I.
2008, “A Model of Housing in the Presence of Adjustment Costs: A Structural Interpretation of Habit Persistence
 American Economic Review
"... model of household consumption and portfolio allocation which incorporates the role of housing as both a consumption good and as a component of wealth. The model captures the following features of the household’s problem: (a) utility depends, probably nonseparably, on two distinct goods (nondurable ..."
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Cited by 94 (5 self)
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model of household consumption and portfolio allocation which incorporates the role of housing as both a consumption good and as a component of wealth. The model captures the following features of the household’s problem: (a) utility depends, probably nonseparably, on two distinct goods (nondurable consumption and housing); (b) nondurable consumption can be adjusted costlessly, but housing is subject to an adjustment cost; (c) households face housing price risk in the sense that the relative price of housing varies over time; and (d) in addition to the house, the household can invest in a wide variety of financial assets. This single, reasonably tractable, model generates testable implications for portfolio allocation, risk aversion, asset pricing, and the dynamics of nondurable consumption. Because the original Grossman and Laroque model considers a utility function in which the durable good is the sole argument, and thus abstracts completely from nondurable consumption, their analysis cannot address either the potential spillover effects of the adjustment costs of the durable good on the dynamics of nondurable consumption, or the implications for portfolio allocation of housing risk arising from variation in the relative price of housing. In addition to generating implications for issues on which the original Grossman and Laroque model was