Habit Formation, the Cross Section of Stock Returns and the Cash-Flow Risk Puzzle
Abstract
Non-linear external habit persistence models, which feature prominently in the recent "equity premium" asset pricing and macroeconomics literature, generate counterfactual predictions in the cross section of stock returns. In particular, we show that in the absence of cross sectional heterogeneity in firms' cash flow risk these models produce a "growth premium," that is, stocks with high price-to-fundamental ratios command a higher premium than stocks with low price-to-fundamental ratios. This implication is at odds with the well established empirical observation of a "value premium" in the cross section of stock returns. Substantial heterogeneity in firms' cash flow risk yields both a value premium as well as most of the stylized facts about the cross-section of stock returns, but it generates a "cash flow risk puzzle": Quantitatively, value stocks have to have "too much" cash flow risk compared to the data to generate empirically plausible value premia.
The PDF above is a preprint version of the article. The final version may be found at < http://dx.doi.org/10.1016/j.jfineco.2010.05.003 >.
Download PDF
Citation
Santos, Tano, and Pietro Veronesi. "Habit Formation, the Cross Section of Stock Returns and the Cash-Flow Risk Puzzle." Journal of Financial Economics 98, no. 2 (November 2010): 385-413.
Each author name for a Columbia Business School faculty member is linked to a faculty research page, which lists additional publications by that faculty member.
Each topic is linked to an index of publications on that topic.