Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/91586 
Authors: 
Year of Publication: 
2007
Series/Report no.: 
SFB 649 Discussion Paper No. 2007-003a
Publisher: 
Humboldt University of Berlin, Collaborative Research Center 649 - Economic Risk, Berlin
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.
Subjects: 
asset pricing
wage rigidity
habit formation
Frisch elasticity
Sharpe ratio
log-linear approximation
JEL: 
E24
E30
G12
Document Type: 
Working Paper

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