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A Model of Housing in the Presence of Adjustment Costs: A Structural Interpretation of Habit Persistence

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  • Marjorie Flavin
  • Shinobu Nakagawa
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    Abstract

    The paper generalizes the Grossman and Laroque (1990) model of optimal consumption and portfolio allocation in the context in which a durable good (or house) subject to adjustment costs is both an argument of the utility function and a component of wealth. Because the Grossman and Laroque model abstracts completely from nondurable consumption, their analysis cannot address either a) the potential spillover effects of the adjustment costs of the durable good on the dynamics of nondurable consumption, or b) the implications for portfolio allocation of housing risk arising from variation in the relative price of housing. By introducing an endogenously determined but infrequently adjusted state variable, the housing model generates many of the implications of the habit persistence model, such as smooth nondurable consumption, state-dependent risk aversion, and a small elasticity of intertemporal substitution despite moderate risk aversion. Using a specification of the utility function which nests both the housing model and habit persistence, the Euler equation for nondurable consumption is estimated with household level data on food consumption and housing from the PSID. The habit persistence model (without housing effects) can be decisively rejected, while the housing model (without habit effects) is not rejected.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10458.

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    Date of creation: May 2004
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    Publication status: published as Flavin, Marjorie and Shinobu Nakagawa. "A Model of Housing in the Presence of Adjustment Costs: A Structural Interpretation of Habit Persistence." American Economic Review 98, 1 (March 2008): 474-95.
    Handle: RePEc:nbr:nberwo:10458

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    Cited by:
    1. Leung, Charles, 2004. "Macroeconomics and housing: a review of the literature," Journal of Housing Economics, Elsevier, vol. 13(4), pages 249-267, December.
    2. Campbell, John, 2006. "Household Finance," Scholarly Articles 3157877, Harvard University Department of Economics.
    3. Carole Bonnet & Laurent Gobillon & Anne Laferrère, 2008. "The effect of widowhood on housing and location choices," Working Papers 154, Institut National d'Études Démographiques (INED).
    4. Nikola Kojucharov & Clyde F. Martin & Robert F. Martin & Lili Xu, 2009. "The subprime mortgage crisis: irrational exuberance or rational error?," Proceedings, Federal Reserve Bank of San Francisco, issue Jan.
    5. Loriana Pelizzon & Guglielmo Weber, 2006. "Are Household Portfolios Efficient? An Analysis Conditional on Housing," "Marco Fanno" Working Papers 0021, Dipartimento di Scienze Economiche "Marco Fanno".
    6. Jan Rouwendal, 2009. "Housing Wealth and Household Portfolios in an Ageing Society," De Economist, Springer, vol. 157(1), pages 1-48, March.
    7. Suntum, Ulrich van, 2009. "Housing, taxation and retirement provision," Journal of Housing Economics, Elsevier, vol. 18(3), pages 249-255, September.
    8. University of Iowa & Galina Vereshchagina, 2007. "Preferences for risk in a dynamic model with consumption commitments," 2007 Meeting Papers 567, Society for Economic Dynamics.
    9. James A. Kahn, 2008. "What drives housing prices?," Staff Reports 345, Federal Reserve Bank of New York.
    10. Xuezheng Qin & Gordon Liu, 2013. "Does the US health care safety net discourage private insurance coverage?," The European Journal of Health Economics, Springer, vol. 14(3), pages 457-469, June.
    11. Nancy L. Stokey, 2007. "Housing and Nondurable Consumption," 2007 Meeting Papers 799, Society for Economic Dynamics.

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