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Risk premia in the consumption capital asset pricing model depend on preferences and dividend. We develop a decomposition which allows a separate treatment of both components. We show that preferences alone determine the risk-return tradeoff measured by the Sharpe-ratio. In general, the risk-return trade-off implied by preferences depends on the elasticity of a preference-based stochastic discount factor for pricing assets with respect to the consumption innovation. Depending on the particular specification of preferences, the absolute value of this elasticity can coincide to the inverse of the elasticity of intertemporal substitution (e.g. for habit formation preferences) or the coefficient of relative risk-aversion (e.g. for Epstein-Zin preferences). We demonstrate that preferences based on a small elasticity of intertemporal substitution, such as habit formation, produce small risk premia once agents are allowed to save. Departing from the complete markets framework, we show that uninsurable risk can only increase the Sharpe-ratio and risk premia if dividends are correlated with individual consumption.

This paper studies the relationships between learning about rules of thumb (represented by classifier systems) and dynamic programming. Building on a result about Markovian stochastic approximation algorithms, we characterize all decision functions that can be asymptotically obtained through classifier system learning, provided the asymptotic ordering of the classifiers is strict. We demonstrate in a robust example that the learnable decision function is in general not unique, not characterized by a strict ordering of the classifiers, and may not coincide with the decision function delivered by the solution to the dynamic programming problem even if that function is attainable. As an illustration we consider the puzzle of excess sensitivity of consumption to transitory income: classifier systems can generate such behavior even if one of the available rules of thumb is the decision function solving the dynamic programming problem, since bad decisions in good times can "feel better" than good decisions in bad times.

Many asset pricing puzzles can be explained when habit formation is added to standard preferences. We show that utility functions with a habit then gives rise to a puzzle of consumption volatility in place of the asset pricing puzzles when agents can choose consumption and labor optimally in response to more fundamental shocks. We show that the consumption reaction to technology shocks are too small by an order of magnitude when a utility includes a habit. Alternative models with consistent and exogenous but stochastic labor input are considered. A model with persistent technology shocks and stochastic labor is shown to be potentially consistent with substantial consumption variability aswell as procyclical labor input and labor productivity even when a habit is present.