Consumption-Based Asset Pricing, Part 2: Habit Formation, Conditional Risks, Long-Run Risks, and Rare Disasters

Journal Article (Review;Journal)

Following Part 1 of this article, which reviews late-1970s to 1990s classic derivations and tests of the consumption capital asset pricing model, here in Part 2 we review more recent developments, some of which are based on utility functions with non-time-separable preferences. Important second-generation consumption-based asset pricing advances are also reviewed, including models with habit formation and long-run risk. These models give large cyclical changes in relative risk aversion and risk premiums as well as lagged impacts of aggregate consumption changes on risk premiums. We review asset pricing with rare disasters and models focused on consumer spending on durables and real estate, as well as the fraction of spending financed by labor income. The second-generation models discussed have more free parameters and fit the empirical data better than did the first-generation consumption-based asset pricing models.

Full Text

Duke Authors

Cited Authors

  • Breeden, DT; Litzenberger, RH; Jia, T

Published Date

  • December 7, 2015

Published In

Volume / Issue

  • 7 /

Start / End Page

  • 85 - 131

Electronic International Standard Serial Number (EISSN)

  • 1941-1375

International Standard Serial Number (ISSN)

  • 1941-1367

Digital Object Identifier (DOI)

  • 10.1146/annurev-financial-091115-014822

Citation Source

  • Scopus