Don't break the habit: structural stability tests of consumption asset pricing models in the UK

This paper investigates the structural stability of four alternative consumption based asset pricing models, the traditional power utility consumption based capital asset pricing model (C-CAPM), the recursive preferences model proposed by Epstein and Zin (1989, 1991), and two habit formation specifications, the form proposed by Abel (1990) and the model of Campbell and Cochrane (1999), using the tests of Hall and Sen (1999). The ability of the models to price stocks and stocks and a short-term interest rate (i.e., the equity premium) is assessed. Evidence is found supportive of both the habit formation specifications and the traditional C-CAPM. The preferred specification based on parameter estimates and structural stability is that of Campbell and Cochrane.