Asset Prices Under Habit Formation and Catching Up with the Joneses

20 Pages Posted: 28 Dec 2006  

Andrew B. Abel

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Date Written: March 1990

Abstract

This paper introduces a utility function that nests three classes of utility functions: (1) time-separable utility functions; (2) "catching up with the Joneses" utility functions that depend on the consumer's level of consumption relative to the lagged cross-sectional average level of consumption; and (3) utility functions that display habit formation. Closed-form solutions for equilibrium asset prices are derived under the assumption that consumption growth is i.i.d. The equity premia under catching up with the Joneses and under habit formation are, for some parameter values, as large as the historically observed equity premium in the United States.

Suggested Citation

Abel, Andrew B., Asset Prices Under Habit Formation and Catching Up with the Joneses (March 1990). NBER Working Paper No. w3279. Available at SSRN: https://ssrn.com/abstract=468393

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