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Habit Formation in an Overlapping Generations Model with Borrowing ConstraintsAmadeu DaSilvaCalifornia State University, Fullerton Mira FarkaCalifornia State University, Fullerton Christos I. GiannikosCUNY - Baruch College; CUNY - The Graduate Center July 2009 European Financial Management, Forthcoming Abstract: We introduce habit-formation in the three-period OLG borrowing-constraint framework of Constantinides, Donaldson, and Mehra (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 U.S. data for relatively small levels of risk aversion.
Number of Pages in PDF File: 36 Keywords: Equity premium puzzle, Overlapping generations model, Habit formation, Risk aversion JEL Classification: G0, G12, D10, E21 Accepted Paper SeriesDate posted: September 18, 2009Suggested CitationContact Information
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