Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model

SFB 649 Discussion Paper No. 2007-003

15 Pages Posted: 24 Feb 2007

See all articles by Harald Uhlig

Harald Uhlig

University of Chicago - Department of Economics

Date Written: January 15, 2007

Abstract

In this paper, I investigate the scope of a model with exogenous habit formation - or "catching up with the Joneses," see Abel (1990) - to generate the observed equity premium as well as other key macroeconomic facts. Along the way, I derive restrictions for four out of eight parameters for a rather general preference specification of habit formation by imposing consistency with long-run growth, the leisure share, the aggregate Frisch elasticity of labor supply, the observed risk-free rate, and the observed Sharpe ratio. I show that a DSGE model with (exogenous and lagged) habits in both leisure and consumption, but not necessarily with additional persistence, is well capable of matching the observed asset market facts as well as macro facts, provided one allows for moderate real wage stickiness and provided one allows for sufficient curvature on preferences, as dictated by the asset market observations. Without wage stickiness, delivery on both the asset pricing implications as well as the macroeconomic implications seems to be much harder.

Suggested Citation

Uhlig, Harald, Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model (January 15, 2007). SFB 649 Discussion Paper No. 2007-003, Available at SSRN: https://ssrn.com/abstract=964853 or http://dx.doi.org/10.2139/ssrn.964853

Harald Uhlig (Contact Author)

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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