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Foundations of Intrinsic Habit Formation

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Author Info
Kareen Rozen () (Cowles Foundation, Yale University)

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Abstract

We provide theoretical foundations for several common (nested) representations of intrinsic linear habit formation. These representations are dynamically consistent and additive, with geometrically decaying coefficients of habit formation. Our axiomatization introduces a revealed preference theory of weaning a decision-maker from her habits using the device of compensation. We characterize linear habit formation in terms of the ability to wean using uniquely determined compensating streams. Moreover, we distinguish between habits that are responsive to weaning and those that are persistent, develop a simple choice-theoretic measure of the rate of habit decay, and demonstrate how to recover the entire sequence of habit formation coefficients from observed choice behavior. We introduce novel monotonicity and separability axioms that are appropriate for time-nonseparable preferences. Our analysis suggests techniques for eliciting dynamic reference points from choice behavior and obtaining discounted utility representations on endogenously generated auxiliary spaces.

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File URL: http://cowles.econ.yale.edu/P/cd/d16a/d1642.pdf
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Publisher Info
Paper provided by Cowles Foundation, Yale University in its series Cowles Foundation Discussion Papers with number 1642.

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Length: 67 pages
Date of creation: Mar 2008
Date of revision:
Handle: RePEc:cwl:cwldpp:1642

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Postal: Yale University, Box 208281, New Haven, CT 06520-8281 USA
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Web page: http://cowles.econ.yale.edu/
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Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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Related research
Keywords: Linear habit formation; Time-nonseparable preferences; Compensation; Weaning; Compensated separability; Gains monotonicity; Endogenously generated auxiliary spaces;

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Find related papers by JEL classification:
C60 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - General
D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
D90 - Microeconomics - - Intertemporal Choice and Growth - - - General

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  1. Shi, Shouyong & Epstein, Larry G, 1993. "Habits and Time Preference," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(1), pages 61-84, February. [Downloadable!] (restricted)
  2. Christopher D. Carroll & Jody Overland & David N. Weil, 1995. "Saving and growth with habit formation," Finance and Economics Discussion Series 95-42, Board of Governors of the Federal Reserve System (U.S.).
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  3. David Backus & Bryan Routledge & Stanley Zin, 2004. "Exotic Preferences for Macroeconomists," Working Papers 04-20, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
    Other versions:
  4. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers 1-90, Wharton School - Weiss Center for International Financial Research.
    Other versions:
  5. Xiaohong Chen & Sydney C. Ludvigson, 2004. "Land of Addicts? An Empirical Investigation of Habit-Based Asset Pricing Behavior," NBER Working Papers 10503, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Matthew Rabin, 2006. "A Model of Reference-Dependent Preferences," The Quarterly Journal of Economics, MIT Press, vol. 121(4), pages 1133-1165, November. [Downloadable!] (restricted)
  7. Gary S. Becker & Kevin M. Murphy, 1986. "A Theory of Rational Addiction," University of Chicago - George G. Stigler Center for Study of Economy and State 41, Chicago - Center for Study of Economy and State.
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  8. Kozicki, Sharon & Tinsley, P. A., 2002. "Dynamic specifications in optimizing trend-deviation macro models," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1585-1611, August. [Downloadable!] (restricted)
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  9. William Neilson, 2006. "Axiomatic reference-dependence in behavior toward others and toward risk," Economic Theory, Springer, vol. 28(3), pages 681-692, 08. [Downloadable!] (restricted)
  10. Ignacio Palacios-Huerta, 2001. "Multiple Addictions," Working Papers 2001-20, Brown University, Department of Economics.
  11. Tjalling C. Koopmans, 1959. "Stationary Ordinal Utility and Impatience," Cowles Foundation Discussion Papers 81, Cowles Foundation, Yale University. [Downloadable!]
  12. Jonathan Shalev, 1994. "Loss Aversion in a Multi-Period Model," Game Theory and Information 9407001, EconWPA, revised 18 Mar 1997. [Downloadable!]
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  13. Wendner, Ronald, 2003. "Do habits raise consumption growth?," Research in Economics, Elsevier, vol. 57(2), pages 151-163, June. [Downloadable!] (restricted)
  14. Uribe, Martin, 2002. "The price-consumption puzzle of currency pegs," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 533-569, April. [Downloadable!] (restricted)
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