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The Role of Habits in Returns Behavior: Evidence from the Stock Market

  • Author(s): Fillat, Jose L.
  • Garduno, Hugo
  • et al.
Abstract

The asset pricing literature has calibrated models with external habits and documented that these models are successful at generating a large set of stylized facts about asset prices. In this paper, we re-consider this evidence by estimating the preference specification using GMM under three different market settings. First we assume complete insurance among all the individuals and estimate the model using aggregate consumption data. Second, we acknowledge that not all the households are actually trading and holding stocks, thus we household-level data. The third market setting is estimated assuming market incompleteness among stockholders along with limited participation. We find evidence that a complete markets model is better able to explain average returns, whereas a model that includes limited participation of agents in the stock market and incomplete consumption insurance among individuals is better able to explain the equity premium and does so with a lower value of the RRA coefficient than a model with complete markets.

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