Department of Economics and Business Economics

Habit Formation, Surplus Consumption and Return Predictability: International Evidence

Research output: Working paper/Preprint Working paperResearch

  • Tom Engsted
  • Stuart Hyde, University of Manchester, United Kingdom
  • Stig V. Møller, Aarhus School of Business, Universit of Aarhus, Denmark
  • School of Economics and Management
On an international post World War II dataset, we use an iterated GMM pro-
cedure to estimate and test the Campbell-Cochrane (1999) habit formation model.
In addition, we analyze the predictive power of the surplus consumption ratio for
future asset returns. We find that, although there are important cross-country
differences, for the majority of countries in our sample the model gets empirical
support in a variety of diffrent dimensions, including reasonable estimates of risk-
free rates, and the model dominates the time-separable power utility model in terms
of pricing errors. Further, for the majority of countries the surplus consumption
ratio captures time-variation in expected returns. Together with the price-dividend
ratio, the surplus consumption ratio contains significant information about future
stock returns, also during the 1990s. Finally, in most countries the surplus con-
sumption ratio is also a powerful predictor of future bond returns.
Original languageEnglish
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages31
Publication statusPublished - 2007

    Research areas

  • Habit formation, Campbell-Cochrane model, surplus consumption

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