Finance and Economics Discussion Series (FEDS)
May 2005
External Habit and the Cyclicality of Expected Stock Returns
Thomas D. Tallarini, Jr. and Harold H. Zhang
Abstract:
We estimate an equilibrium asset pricing model in which agents' preferences have an unobserved external habit using the efficient method of moments (EMM). Given the estimated structural parameters we examine the cyclical behavior of expected stock returns in the model. We find that the estimated structural parameters imply countercyclical expected stock returns as documented in existing empirical studies. The model, however, is still rejected at the one percent level. Detailed examination of the moment conditions in our estimation indicates that the model performs reasonably well in matching the mean of returns, but it fails to capture the higher order moments.
Keywords: External habit, expected returns, asset pricing, efficient method of moments
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.