In intertemporal asset pricing models, transaction costs are usually neglected. In this paper we explicitly incorporate transaction costs in these models and analyze to what extent this extension is helpful in explaining the cross-section of expected returns. An empirical analysis using CRSP data on size-based portfolios examines the role of the transaction costs and shows that incorporating such costs in the consumption-based model with power utility does not yield very satisfactory results. However, the introduction of habit persistence substantially improves the model. We find rather strong evidence of habit persistence in monthly consumption data. The plots of the models' pricing errors indicate that an intertemporal asset pricing model with transaction costs and habit persistence explains the cross-sectional variation in the portfolio returns quite accurately.

habit persistence, intertemporal asset pricing, pricing errors, transaction costs
Estimation (jel C13), Model Evaluation and Testing (jel C52), Asset Pricing (jel G12)
dx.doi.org/10.1016/S0927-5398(99)00003-1, hdl.handle.net/1765/12641
ERIM Top-Core Articles
Journal of Empirical Finance
Erasmus Research Institute of Management

Marquering, W.A, & Verbeek, M.J.C.M. (1999). An Empirical Analysis of Intertemporal Asset Pricing Models with Transactions Costs and Habit Persistence. Journal of Empirical Finance, 243–265. doi:10.1016/S0927-5398(99)00003-1