TY - JOUR
T1 - Habit formation
T2 - A resolution of the equity premium puzzle?
AU - Otrok, Christopher
AU - Ravikumar, B.
AU - Whiteman, Charles H.
N1 - Funding Information:
We thank George Constantinides, Dave DeJong, Lars Hansen, Beth Ingram, Rody Manuelli, Mark Watson and an anonymous referee for helpful comments. We gratefully acknowledge the support provided for this research by the National Science Foundation under grants SES-0082237 and SES-0082230.
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
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U2 - 10.1016/S0304-3932(02)00147-2
DO - 10.1016/S0304-3932(02)00147-2
M3 - Article
AN - SCOPUS:0036742676
SN - 0304-3932
VL - 49
SP - 1261
EP - 1288
JO - Journal of Monetary Economics
JF - Journal of Monetary Economics
IS - 6
ER -