Journal of Financial Economics Vol. 98 No. 2 2010
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 premiums.
- DOI
- 10.1016/j.jfineco.2010.05.003
- Volume
- 98
- Issue
- 2
- Pages
- 385-413
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref