Habit formation and the equity-premium puzzle: a skeptical view
We argue that ceteris paribus, introducing a habit that resolves the equity premium puzzle is equivalent to increasing the coefficient of relative risk aversion. Thus, if habit is modeled subject to the constraint that the Arrow-Pratt coefficient of relative risk aversion is held at a constant "...
| Main Authors: | , |
|---|---|
| Format: | Working paper |
| Published: |
University of Oxford
2004
|
| _version_ | 1797060587889360896 |
|---|---|
| author | Sussman, O Athanasoulis, S |
| author_facet | Sussman, O Athanasoulis, S |
| author_sort | Sussman, O |
| collection | OXFORD |
| description | We argue that ceteris paribus, introducing a habit that resolves the equity premium puzzle is equivalent to increasing the coefficient of relative risk aversion. Thus, if habit is modeled subject to the constraint that the Arrow-Pratt coefficient of relative risk aversion is held at a constant "acceptable" level, the effect on the equity premium is not quantitatively significant. In a dynamic setting, the fluctuations of the habit increase the equity premium, slightly. However, modest improvement in the model's predictive power comes at a cost of generating unrealistic fluctuations in the risk-free interest rate. Our analysis of these findings yields the following result: a habit is observationally equivalent,up to afirst order approximation, to a higher relative risk aversion and to a preference shock. Both these effects are known to be insufficient for resolving the equity-premium puzzle. |
| first_indexed | 2024-03-06T20:19:11Z |
| format | Working paper |
| id | oxford-uuid:2d397b1b-3418-46ce-b387-66b73f33f792 |
| institution | University of Oxford |
| last_indexed | 2024-03-06T20:19:11Z |
| publishDate | 2004 |
| publisher | University of Oxford |
| record_format | dspace |
| spelling | oxford-uuid:2d397b1b-3418-46ce-b387-66b73f33f7922022-03-26T12:41:30ZHabit formation and the equity-premium puzzle: a skeptical viewWorking paperhttp://purl.org/coar/resource_type/c_8042uuid:2d397b1b-3418-46ce-b387-66b73f33f792Bulk import via SwordSymplectic ElementsUniversity of Oxford2004Sussman, OAthanasoulis, SWe argue that ceteris paribus, introducing a habit that resolves the equity premium puzzle is equivalent to increasing the coefficient of relative risk aversion. Thus, if habit is modeled subject to the constraint that the Arrow-Pratt coefficient of relative risk aversion is held at a constant "acceptable" level, the effect on the equity premium is not quantitatively significant. In a dynamic setting, the fluctuations of the habit increase the equity premium, slightly. However, modest improvement in the model's predictive power comes at a cost of generating unrealistic fluctuations in the risk-free interest rate. Our analysis of these findings yields the following result: a habit is observationally equivalent,up to afirst order approximation, to a higher relative risk aversion and to a preference shock. Both these effects are known to be insufficient for resolving the equity-premium puzzle. |
| spellingShingle | Sussman, O Athanasoulis, S Habit formation and the equity-premium puzzle: a skeptical view |
| title | Habit formation and the equity-premium puzzle: a skeptical view |
| title_full | Habit formation and the equity-premium puzzle: a skeptical view |
| title_fullStr | Habit formation and the equity-premium puzzle: a skeptical view |
| title_full_unstemmed | Habit formation and the equity-premium puzzle: a skeptical view |
| title_short | Habit formation and the equity-premium puzzle: a skeptical view |
| title_sort | habit formation and the equity premium puzzle a skeptical view |
| work_keys_str_mv | AT sussmano habitformationandtheequitypremiumpuzzleaskepticalview AT athanasouliss habitformationandtheequitypremiumpuzzleaskepticalview |