Can Habit Formation Be Reconciled with Business Cycle Facts?

Lettau, Martin; Uhlig, Harald

doi:10.1006/redy.1998.0035

Cited by 235 publications

(185 citation statements)

References 12 publications

(6 reference statements)

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“…Lettau and Uhlig (2000) embed the habit specification employed by C-C in a standard real business cycle model and found that it creates a number of macroeconomic anomalies. For example, consumption turns out to be extremely smooth: the quarterly standard deviation is a mere 0.02 percent which is 70 times smaller than the volatility observed in the U.S. data.…”

Section: Results: Macroeconomicsmentioning

confidence: 99%

“…Unfortunately, the extension of the external habit model to study macroeconomic questions has not been straightforward. For example, Lettau and Uhlig (2000) show that incorporating external habit results in a number of anomalies in an otherwise standard business cycle model. One has to introduce a number of frictions in production and more habits in leisure and so on, in order to carefully balance and counteract its effect.…”

Section: Introductionmentioning

confidence: 99%

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A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?

Guvenen

2003

SSRN Journal

100

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In this paper we study the asset pricing implications of a parsimonious twoagent macroeconomic model with two key features: limited participation in the stock market and heterogeneity in the elasticity of intertemporal substitution. The parameter values for the model are taken from the business cycle literature and are not calibrated to match any financial statistic. Yet, with a risk aversion of two, the model is able to explain a large number of asset pricing phenomena including all the facts matched by the external habit model of Campbell and Cochrane (1999). Examples in this list include a high equity premium and a low risk-free rate; a counter-cyclical risk premium, volatility and Sharpe ratio; predictable stock returns with coefficients and R 2 values of long-horizon regressions matching their empirical counterparts, among others. In addition the model generates a risk-free rate with low volatility (5.7 percent annually) and with high persistence. We also show that the similarity of our results to those from an external habit model is not a coincidence: the model has a reduced form representation which is remarkably similar to Campbell and Cochrane's framework for asset pricing. However, the macroeconomic implications of the two models are quite different, favoring the limited participation model. Moreover, we show that policy analysis yields dramatically different conclusions in each framework.

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Section: Results: Macroeconomicsmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?

Guvenen

2003

SSRN Journal

100

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“…For this version of the model economy the implied equity premium is quite large (1%). In other words, once the volatility problem has been overcome, the present incomplete-markets model is capable of generating a 10 Jermann (1998) and Lettau and Uhlig (2000) introduce a quadratic adjustment cost to break the tight link between stock returns and the net marginal product of capital, and Boldrin et al (2001) use a two-sector model with limited inter-sectoral factor mobility. 5 substantial equity premium.…”

Section: Introductionmentioning

confidence: 99%

Asset returns in an endogenous growth model with incomplete markets

Krebs

Wilson

2004

Journal of Economic Dynamics and Control

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractThis paper analyzes a class of stochastic endogenous growth models with uninsurable idiosyncratic income risk. The model economy is populated by infinitely-lived households who own and operate their own business, work for a stock company, and participate in stock and bond markets. Households have time-and state-additive log-utility preferences and production functions exhibit constant returns to scale with respect to produced input factors (physical and human capital). This paper shows that if the idiosyncratic component of productivity and depreciation shocks is unpredictable, then there exists an equilibrium in which households choose not to trade bonds. This no-trade result implies that equilibria can be found by solving a one-agent decision problem. The paper also analyzes the asset return implications of a calibrated model economy with an individual income process that displays realistic variations in idiosyncratic income risk. The calibrated model economy generates a sizable mean equity premium (1%) if the volatility of implied stock returns matches the volatility of observed U.S. stock returns.JEL Classification Numbers: D52, D58, G12.

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“…In macroeconomics, dynamic stochastic general equilibrium models (DSGE) have been very successful in explaining co-movements in aggregate data, but relatively less effort has been made to understand their asset market implications (recent work includes Jermann, 1998;Tallarini, 2000;Lettau and Uhlig, 2000;Boldrin, Christiano and Fisher, 2001). 1 One main advantage of using general equilibrium models to explain asset market phenomena is that the asset-pricing kernel is consistent with the macro dynamics, which offers an excellent guide to the future development of models in both macroeconomics and finance.…”

mentioning

confidence: 99%

Risk premia in general equilibrium

Posch¹

2011

Journal of Economic Dynamics and Control

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This paper shows that non-linearities can generate time-varying and asymmetric risk premia over the business cycle. These (empirical) key features become relevant and asset market implications improve substantially when we allow for non-normalities in the form of rare disasters. We employ explicit solutions of dynamic stochastic general equilibrium models, including a novel solution with endogenous labor supply, to obtain closed-form expressions for the risk premium in production economies. We find that the curvature of the policy functions affects the risk premium through controlling the individual's effective risk aversion.JEL classification: E21, G11, O41

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Can Habit Formation Be Reconciled with Business Cycle Facts?

Cited by 235 publications

References 12 publications

A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?

A Parsimonious Macroeconomic Model for Asset Pricing: Habit Formation or Cross-sectional Heterogeneity?

Asset returns in an endogenous growth model with incomplete markets

Risk premia in general equilibrium

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