Asset prices under habit formation and reference-dependent preferences

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This article explains the high level and the countercyclical variation of the equity premium in a consumption-based asset pricing model with low large-scale risk aversion. Investors have gain-loss utility over consumption relative to slowly time-varying habit. Stocks deliver low returns in recessions when consumption falls below habit; investors therefore require a high premium for holding stocks. The model's conditional moment restrictions are tested on consumption and asset returns data. The empirical estimate of large-scale risk aversion is low, whereas the estimate of loss aversion agrees with prior experimental evidence.

Original languageEnglish (US)
Pages (from-to)131-143
Number of pages13
JournalJournal of Business and Economic Statistics
Issue number2
StatePublished - Apr 2008
Externally publishedYes

All Science Journal Classification (ASJC) codes

  • Statistics and Probability
  • Social Sciences (miscellaneous)
  • Economics and Econometrics
  • Statistics, Probability and Uncertainty


  • Asset pricing
  • Consumption
  • Equity premium
  • Habit formation
  • Loss aversion


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