Consumption Habit and Equity Premium in the G7 Countries
The consumption capital asset pricing model (C-CAPM) fails to explain the observed equity premia apart from considering implausible values of the risk aversion coefficient. This equity premium puzzle has been attributed in particular to the time-separability of the consumers' preferences. This paper investigates empirically the ability of the C-CAPM to solve this puzzle once assumed that consumption behaviour presents habit formation. From the estimation of the model's parameters for the G7 countries, we show that the consumption model with habit formation is able to account for financial asset returns with more reasonable preference.
Consumption, habit formation, equity premium, Generalized method of moments
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