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Abstract

This paper introduces a utility function that nests three classes of utility functions: (1) time-separable utility functions; (2) "catching up with the Joneses" utility functions that depend on the consumer’s level of consumption relative to the lagged cross-sectional average level of consumption; and (3) utility functions that display habit formation. Closed-form solutions for equilibrium asset prices are derived under the assumption that consumption growth is i.i.d. The equity premia under catching up with the Joneses and under habit formation are, for some parameter values, as large as the historically observed equity premium in the United States.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 1-90.

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Handle: RePEc:fth:pennfi:1-90

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1. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
   
   • Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
2. James M. Nason, 1988. "The equity premium and time-varying risk behavior," Finance and Economics Discussion Series 11, Board of Governors of the Federal Reserve System (U.S.).
3. Sundaresan, Suresh M, 1989. "Intertemporally Dependent Preferences and the Volatility of Consumption and Wealth," Review of Financial Studies, Society for Financial Studies, vol. 2(1), pages 73-89.
4. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.

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1. Status and Asset Pricing Thread Taking Baby Steps
   by Eric Falkenstein in Falkenblog on 2010-07-13 13:11:00
2. Status and Asset Pricing Thread Taking Baby Steps
   by Eric Falkenstein in Falkenblog on 2010-07-13 13:11:00

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