Abstract
Campbell and Cochrane (1999b) habit formation model is able to resolve the equity premium and riskless interest rate puzzles, but only for high values of relative risk aversion. In this paper, I incorporate transactions costs in the Campbell and Cochrane (1999b) model and find that the required level of relative risk aversion at the steady state reduces from 35 to 15. Thus, transactions costs seem able to reduce, but not completely solve, the remaining puzzle.
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