Relative Consumption: The Strength of Internal and External Habits

33 Pages Posted: 3 Nov 2014 Last revised: 4 Nov 2014

See all articles by Stefan Zimmermann

Stefan Zimmermann

University of Vienna - Faculty of Business, Economics, and Statistics

Date Written: August 8, 2014

Abstract

This paper investigates the presence and strength of internal and external habit formation in consumption, using monthly household data. The habit hypothesis is used to explain empirical regularities in macroeconomics and finance. Empirical studies based on aggregate data (macro-evidence) leave the micro-behavior unexplored. The micro-evidence is inconclusive and primarily based on food consumption data. Unfortunately, food consumption is a bad proxy for total consumption — mainly, because food consumption preferences differ considerably from consumption preferences of other goods (Shea (1994)). Thus, I use total household consumption data to test the Euler equations of an additive habit formation model. There is evidence for internal and external habits; the external habit effect is about three times larger than the internal effect. Extensions to alternative habit coefficients are provided.

Keywords: Behavioral Economics, Habit Formation, Social Comparison, Household Consumption, Dynamic Panel Data, Micro-Econometrics

JEL Classification: A12, C12, C23, C26, D12, D91

Suggested Citation

Zimmermann, Stefan, Relative Consumption: The Strength of Internal and External Habits (August 8, 2014). Available at SSRN: https://ssrn.com/abstract=2518159 or http://dx.doi.org/10.2139/ssrn.2518159

Stefan Zimmermann (Contact Author)

University of Vienna - Faculty of Business, Economics, and Statistics ( email )

Vienna, A-1090
Austria

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