BFS 2002

Contributed Talk

In this paper, I show that an extension of CCAPM that incorporates the idea of limited participation and the time-varying and predictable nature of labor's share of output goes a long way toward explaining several empirical regularities in asset pricing, including the equity premium puzzle, the riskfree rate puzzle, the equity volatility puzzle, and the time-varying and predictable nature of asset returns.
The structure of the model is such that the aggregate labor income can be interpreted as the habit stock of aggregate consumption. Under this interpretation, our model nests several popular habit formation models in the asset pricing literature. Since the aggregate labor income growth rate is locally stochastic and arbitrarily correlated with the aggregate consumption growth rate, our model gives rise to a realistic model of the real term structure.       http://www.stanford.edu/~dq/Research/SHABIT/habit.pdf