External Habit in a Production Economy
AbstractA unified framework for understanding asset prices and aggregate fluctuations is critical for understanding both issues. I show that a real business cycle model with external habit preferences and capital adjustment costs provides one such framework. The estimated model matches the first two moments of the equity premium and risk-free rate, return and dividend predictability regressions, and the second moments of output, consumption, and investment. The model also endogenizes a key mechanism of consumption-based asset pricing models. In order to address the Shiller volatility puzzle, external habit, long-run risk, and disaster models require the assumption that the volatility of marginal utility is countercyclical. In the model, this countercyclical volatility arises endogenously. Production makes precautionary savings effects show up in consumption. These effects lead to countercyclical consumption volatility and countercyclical volatility of marginal utility. External habit amplifies this channel and makes it quantitatively significant.
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Bibliographic InfoPaper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2013-16.
Date of creation: Oct 2013
Date of revision:
Find related papers by JEL classification:
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
- E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-10-18 (All new papers)
- NEP-DGE-2013-10-18 (Dynamic General Equilibrium)
- NEP-MAC-2013-10-18 (Macroeconomics)
- NEP-UPT-2013-10-18 (Utility Models & Prospect Theory)
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Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- External Habit in a Production Economy
by Christian Zimmermann in NEP-DGE blog on 2013-10-21 17:36:50
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