02197cam a22002417 4500001000600000003000500006005001700011008004100028100002200069245015500091260006600246490004100312500001800353520120200371530006101573538007201634538003601706700002201742710004201764830007601806856003701882856003601919w4995NBER20141123063710.0141123s1995 mau||||fs|||| 000 0 eng d1 aCampbell, John Y.10aBy Force of Habith[electronic resource]:bA Consumption-Based Explanation of Aggregate Stock Market Behavior /cJohn Y. Campbell, John H. Cochrane. aCambridge, Mass.bNational Bureau of Economic Researchc1995.1 aNBER working paper seriesvno. w4995 aJanuary 1995.3 aWe present a consumption-based model that explains the procyclical variation of stock prices, the long-horizon predictability of excess stock returns, and the countercyclical variation of stock market volatility. Our model has an i.i.d. consumption growth driving process, and adds a slow-moving external habit to the standard power utility function. The latter feature produces cyclical variation in risk aversion, and hence in the prices of risky assets. Our model also predicts many of the difficulties that beset the standard power utility model, including Euler equation rejections, no correlation between mean consumption growth and interest rates, very high estimates of risk aversion, and pricing errors that are larger than those of the static CAPM. Our model captures much of the history of stock prices, given only consumption data. Since our model captures the equity premium, it implies that fluctuations have important welfare costs. Unlike many habit-persistence models, our model does not necessarily produce cyclical variation in the risk free interest rate, nor does it produce an extremely skewed distribution or negative realizations of the marginal rate of substitution. aHardcopy version available to institutional subscribers. aSystem requirements: Adobe [Acrobat] Reader required for PDF files. aMode of access: World Wide Web.1 aCochrane, John H.2 aNational Bureau of Economic Research. 0aWorking Paper Series (National Bureau of Economic Research)vno. w4995.4 uhttp://www.nber.org/papers/w499541uhttp://dx.doi.org/10.3386/w4995