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Deep Habits

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  • Morten Ravn
  • Stephanie Schmitt-Grohe
  • Martin Uribe

Abstract

This paper generalizes the standard habit formation model to an environment in which agents form habits over individual varieties of goods as opposed to over a composite consumption good. We refer to this preference specification as `deep habit formation'. Under deep habits, the demand function faced by individual producers depends on past sales. This feature is typically assumed ad-hoc in customer market and brand switching cost models. A central result of the paper is that deep habits give rise to countercyclical markups, which is in line with the empirical evidence. This result is important because ad-hoc formulations of customer-market and switching-cost models have been criticized for implying procyclical and hence counterfactual markup movements. The paper also provides econometric estimates of the parameters pertaining to the deep habit model.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10261.

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Date of creation: Feb 2004
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Publication status: published as Ravn, Morten, Stephenaie Schmitt-Grohe and Martin Uribe. "Deep Habits," Review of Economic Studies, 2006, v73(1,Jan), 195-218.
Handle: RePEc:nbr:nberwo:10261

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  1. Abel, Andrew B., 1952-, 1995. "Options, the value of capital, and investment," Working papers 3843-95., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  3. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Inflation Targeting Rules," NBER Working Papers 9939, National Bureau of Economic Research, Inc.
  4. Gali, J., 1991. "Monopolistic Competition, Business Cycles and the Composition of Aggregate Demand," Papers 92-03, Columbia - Graduate School of Business.
  5. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 1-90, Wharton School Rodney L. White Center for Financial Research.
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  7. Ferson, Wayne E. & Constantinides, George M., 1991. "Habit persistence and durability in aggregate consumption: Empirical tests," Journal of Financial Economics, Elsevier, vol. 29(2), pages 199-240, October.
  8. Julio J. Rotemberg & Michael Woodford, 1991. "Markups and the Business Cycle," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 63-140 National Bureau of Economic Research, Inc.
  9. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
  10. Morten Ravn & Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Deep Habits," NBER Working Papers 10261, National Bureau of Economic Research, Inc.
  11. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
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  16. Dunn, Kenneth B. & Singleton, Kenneth J., 1986. "Modeling the term structure of interest rates under non-separable utility and durability of goods," Journal of Financial Economics, Elsevier, vol. 17(1), pages 27-55, September.
  17. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  18. Braun, Phillip A. & Constantinides, George M. & Ferson, Wayne E., 1993. "Time nonseparability in aggregate consumption : International evidence," European Economic Review, Elsevier, vol. 37(5), pages 897-920, June.
  19. Rotemberg, Julio J & Saloner, Garth, 1986. "A Supergame-Theoretic Model of Price Wars during Booms," American Economic Review, American Economic Association, vol. 76(3), pages 390-407, June.
  20. Julio J. Rotemberg & Michael Woodford, 1993. "Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets," NBER Working Papers 4502, National Bureau of Economic Research, Inc.
  21. G. Constantinides, 1990. "Habit formation: a resolution of the equity premium puzzle," Levine's Working Paper Archive 1397, David K. Levine.
  22. Heaton, John, 1995. "An Empirical Investigation of Asset Pricing with Temporally Dependent Preference Specifications," Econometrica, Econometric Society, vol. 63(3), pages 681-717, May.
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