The dissertation consists of three essays. In the first essay I present a generalized asset pricing model that structurally nests two types of habit formation persistence: "catching up with Joneses" (external habit formation) and "time non-separable" (internal habit formation) preference specifications. Using this model, I explore the following question: to what extent does an individual consurner's preference depend on her own consumption history as opposed to the aggregate consumption history? Recently this question has attracted a lot of attention with researchers trying to understand the nature of the habit formation process of past consumption realizations. I derive the asset pricing implications of this model and confront there with the observed consumption and asset return data to determine the relative importance of "catching up with Joneses" and internal habit persistence. I test the model using US postwar seasonally adjusted quarterly data on consumption expenditures, Fama-French portfolio and Treasury long-term bond portfolio returns of different horizons. Using long-horizon returns, I show that internal habit formation with a sufficiently long history of consumption choices is more consistent with observed asset and bond returns than "catching up with Joneses" preferences. These results have important implications for researchers attempting to provide microeconomic foundations of habit formation.;The second essay is a result of joint work with my advisor Professor Qiang Dai. A consumption-based asset pricing model with stochastic internal habit formation is econometrically estimated and tested using generalized method of moments. The model departs from existing models with deterministic internal habit (e.g., Dunn and Singleton (1986), Ferson and Constantinides (1991), and Heaton (1995)) by introducing shocks to the coefficients in the distributed lag specification of consumption habit and consequently an additional shock to the marginal rate of substitution. The stochastic shocks to the consumption habit are persistent and provide an additional source of time-variation in expected returns. Using Treasury bond returns and broad equity market index returns, we show that stochastic internal habit formation models resolve the dichotomy between autocorrelation properties of stochastic discount factor and those of expected returns and provide better explanation of time-variation in expected returns compared to models with either deterministic habit or stochastic external habit. It is an important insight given that Singleton (1993) has shown that the rejection of consumption-based asset pricing models is mainly due to the time-varying properties of bond returns, rather than those of stock returns.;The third essay is on informational trading and corporate governance in emerging markets. This is a result of collaborative work with Professor Jianping Mei and a fellow graduate student Lubomir Litov. We develop a new approach to extract information on corporate governance in emerging markets based on trading data. We apply the theoretical framework of Llorente, Michaely, Saar, and Wang (2002) to analyze the relation between daily volume and first-order return autocorrelation for individual stocks in emerging markets. We find strong evidence of return continuation following high volume days, suggesting the presence of private information trading for many emerging market stocks. Controlling for liquidity, we find that better internal corporate governance mechanism and country-specific rule of law contribute to better public information flow and less private information trading on the stock market. These results suggest return autocorrelation and trading volume carry useful information about corporate governance in emerging markets.
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