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Habit Formation in an Overlapping Generations Model with Borrowing Constraints
Author(s) -
DaSilva Amadeu,
Farka Mira,
Giannikos Christos
Publication year - 2011
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/j.1468-036x.2009.00523.x
Subject(s) - habit , economics , overlapping generations model , equity premium puzzle , consumption (sociology) , econometrics , equity (law) , persistence (discontinuity) , microeconomics , psychology , capital asset pricing model , engineering , social psychology , social science , sociology , geotechnical engineering , political science , law
We introduce habit‐formation in the three‐period OLG borrowing‐constrained framework of Constantinides et al. (2002) by allowing the utility of the middle‐aged (old) to depend on consumption when young (middle‐aged). This specification enables us to separate the effect of the two habit parameters (middle‐aged and old) since each representative age‐group can face different levels of habit persistence. The two‐habit setup underlines some important issues with regards to savings and security returns which do not always conform to the standard findings in the literature. In addition, the model produces equity premium consistent with US data for relatively small levels of risk aversion.