VOLUME XIV
WINTER 2006

DURABLE CONSUMPTION, HABITS AND THE STOCK MARKET
 
ELENA MÁRQUEZ DE LA CRUZ
Universidad Complutense de Madrid
 
The Consumption based Capital Asset Pricing Model (CCAPM) has been the subject of various empirical studies for different economies, giving rise to the so-called risk equity premium puzzle. This puzzle is the result of the inability of the model to explain the observed risk premiums except in cases where implausible values are used for one of the agents’ preference parameters, namely, the relative risk aversion parameter. On the other hand, the high values for this parameter necessary for the model to fit with empirical data result in interest rates that are higher than those observed empirically. This gives rise to a second empirical puzzle, the interest rate puzzle. In this work, we examine the CCAPM model, considering the possibility of the development of external habits in consumption and including the service flow that the consumption of durable goods generates in the consumption variable, with the aim of analyzing the effect these factors have on the aforementioned empirical puzzles.
 
Key words: CCAPM; durable consumption goods; external habits.
JEL classification: E44, G12.

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