Habit formation, incomplete markets, and the significance of regional risk for expected returns

Research output: Contribution to journalArticle

16 Citations (Scopus)

Abstract

This paper introduces a consumption-based capital asset pricing model (CCAPM) that combines undiversifiable income shocks and external habit formation. Using US state-level data, the paper provides realistic estimates for preference parameters when the external habit of the state investors is based on the consumption of the four Census regions. The model also implies four asset pricing factors: the cross-sectional means of consumption growth and habit growth (capturing national systematic risk) and the cross-sectional variances of consumption growth and habit growth (capturing regional systematic risk). This four-factor model has greater power in explaining expected returns than the CCAPM described in Breeden (1979).

Original languageEnglish (US)
Pages (from-to)2139-2172
Number of pages34
JournalReview of Financial Studies
Volume21
Issue number5
DOIs
StatePublished - Sep 2008
Externally publishedYes

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Expected returns
Habit formation
Incomplete markets
External habit
Consumption growth
Habit
Capital asset pricing model
Systematic risk
Asset pricing
Income shocks
Investors
Census
U.S. States
Factors

ASJC Scopus subject areas

  • Finance
  • Accounting
  • Economics and Econometrics

Cite this

Habit formation, incomplete markets, and the significance of regional risk for expected returns. / Korniotis, George.

In: Review of Financial Studies, Vol. 21, No. 5, 09.2008, p. 2139-2172.

Research output: Contribution to journalArticle

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