Habit formation: A resolution of the equity premium puzzle?

Christopher Otrok, B. Ravikumar, Charles H. Whiteman

Research output: Contribution to journalArticle

41 Citations (Scopus)

Abstract

We explore how the introduction of habit preferences into the simple intertemporal consumption-based capital asset pricing model "solves" the equity premium and risk-free rate puzzles. While agents with time-separable preferences care only about the overall volatility of consumption, we show that agents with habit preferences care not only about overall volatility, but also about the temporal distribution of that volatility. Specifically, habit agents are much more averse to high-frequency fluctuations than to low-frequency fluctuations. In fact, the size of the equity premium in the habit model is determined by a relatively insignificant amount of high-frequency volatility in U.S. consumption.

Original languageEnglish (US)
Pages (from-to)1261-1288
Number of pages28
JournalJournal of Monetary Economics
Volume49
Issue number6
DOIs
StatePublished - Sep 2002
Externally publishedYes

Fingerprint

Habit
Equity premium puzzle
Habit formation
Fluctuations
Equity premium
Separable preferences
Risk-free rate puzzle
Equity risk
Capital asset pricing model

Keywords

  • Equity premium
  • Habit formation

ASJC Scopus subject areas

  • Economics and Econometrics
  • Finance

Cite this

Habit formation : A resolution of the equity premium puzzle? / Otrok, Christopher; Ravikumar, B.; Whiteman, Charles H.

In: Journal of Monetary Economics, Vol. 49, No. 6, 09.2002, p. 1261-1288.

Research output: Contribution to journalArticle

Otrok, Christopher ; Ravikumar, B. ; Whiteman, Charles H. / Habit formation : A resolution of the equity premium puzzle?. In: Journal of Monetary Economics. 2002 ; Vol. 49, No. 6. pp. 1261-1288.
@article{5c73b44e2dda4e08a1e7cd01c3074b1f,
title = "Habit formation: A resolution of the equity premium puzzle?",
abstract = "We explore how the introduction of habit preferences into the simple intertemporal consumption-based capital asset pricing model {"}solves{"} the equity premium and risk-free rate puzzles. While agents with time-separable preferences care only about the overall volatility of consumption, we show that agents with habit preferences care not only about overall volatility, but also about the temporal distribution of that volatility. Specifically, habit agents are much more averse to high-frequency fluctuations than to low-frequency fluctuations. In fact, the size of the equity premium in the habit model is determined by a relatively insignificant amount of high-frequency volatility in U.S. consumption.",
keywords = "Equity premium, Habit formation",
author = "Christopher Otrok and B. Ravikumar and Whiteman, {Charles H.}",
year = "2002",
month = "9",
doi = "10.1016/S0304-3932(02)00147-2",
language = "English (US)",
volume = "49",
pages = "1261--1288",
journal = "Journal of Monetary Economics",
issn = "0304-3932",
publisher = "Elsevier",
number = "6",

}

TY - JOUR

T1 - Habit formation

T2 - A resolution of the equity premium puzzle?

AU - Otrok, Christopher

AU - Ravikumar, B.

AU - Whiteman, Charles H.

PY - 2002/9

Y1 - 2002/9

N2 - We explore how the introduction of habit preferences into the simple intertemporal consumption-based capital asset pricing model "solves" the equity premium and risk-free rate puzzles. While agents with time-separable preferences care only about the overall volatility of consumption, we show that agents with habit preferences care not only about overall volatility, but also about the temporal distribution of that volatility. Specifically, habit agents are much more averse to high-frequency fluctuations than to low-frequency fluctuations. In fact, the size of the equity premium in the habit model is determined by a relatively insignificant amount of high-frequency volatility in U.S. consumption.

AB - We explore how the introduction of habit preferences into the simple intertemporal consumption-based capital asset pricing model "solves" the equity premium and risk-free rate puzzles. While agents with time-separable preferences care only about the overall volatility of consumption, we show that agents with habit preferences care not only about overall volatility, but also about the temporal distribution of that volatility. Specifically, habit agents are much more averse to high-frequency fluctuations than to low-frequency fluctuations. In fact, the size of the equity premium in the habit model is determined by a relatively insignificant amount of high-frequency volatility in U.S. consumption.

KW - Equity premium

KW - Habit formation

UR - http://www.scopus.com/inward/record.url?scp=0036742676&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=0036742676&partnerID=8YFLogxK

U2 - 10.1016/S0304-3932(02)00147-2

DO - 10.1016/S0304-3932(02)00147-2

M3 - Article

AN - SCOPUS:0036742676

VL - 49

SP - 1261

EP - 1288

JO - Journal of Monetary Economics

JF - Journal of Monetary Economics

SN - 0304-3932

IS - 6

ER -