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By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior (1999)
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@MISC{Campbell99byforce,
author = {John Y. Campbell and John H. Cochrane},
title = {By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior },
year = {1999}
}
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Abstract
We present a consumption-based model that explains a wide variety of dynamic asset pricing phenomena, including the procyclical variation of stock prices, the long-horizon predictability of excess stock returns, and the countercyclical variation of stock market volatility. The model captures much of the history of stock prices from consumption data. It explains the short- and long-run equity premium puzzles despite a low and constant risk-free rate. The results are essentially the same whether we model stocks as a claim to the consumption stream or as a claim to volatile dividends poorly correlated with consumption. The model is driven by an independently and identically distributed consumption growth process and adds a slow-moving external habit to the standard power utility function. These features generate slow countercyclical variation in risk premia. The model posits a fundamentally novel description of risk premia: Investors fear stocks primarily because they do poorly in recessions unrelated to the risks of long-run average consumption growth.
Keyphrases
aggregate stock market behavior consumption-based explanation risk premia stock price novel description dynamic asset pricing phenomenon long-run average con-sumption growth consumption stream consumption-based model countercyclical variation procyclical variation stock market vol-atility consumption data constant risk-free rate consumption growth process excess stock return slow countercyclical variation long-horizon predictability standard power utility function slow-moving external habit wide vari-ety long-run equity pre-mium puzzle volatile dividend
