We suggest an iterated GMM approach to estimate and test the consumption based habit persistence model of Campbell and Cochrane, and we apply the approach on annual and quarterly Danish stock and bond returns. For comparative purposes we also estimate and test the standard constant relative risk-aversion (CRRA) model. In addition, we compare the pricing errors of the different models using Hansen and Jagannathan's specification error measure. The main result is that for Denmark the Campbell-Cochrane model does not seem to perform markedly better than the CRRA model. For the long annual sample period covering more than 80 years there is absolutely no evidence of superior performance of the Campbell-Cochrane model. For the shorter and more recent quarterly data over a 20-30 year period, there is some evidence of counter-cyclical time-variation in the degree of risk-aversion, in accordance with the Campbell-Cochrane model, but the model does not produce lower pricing errors or more plausible parameter estimates than the CRRA model.
International Journal of Finance and Economics, 2010, Vol 15, Issue 3, p. 213-227