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Habit Persistence and Welfare Gains from International Asset Trade

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  • Egil Matsen

    ()
    (Department of Economics, Norwegian University of Science and Technology)

Abstract

We introduce habit formation in a model that studies the link between international trade in financial assets, economic growth, and welfare. As with time separable preferences asset trade increases the mean growth rate, but it also increases growth-volatility. We demonstrate that the welfare gain from asset trade is lower with habit persistence in consumption. This reflects that the habit-forming households perceive the higher growth-volatility as a higher cost to obtain increased average growth. Calibrating the model to data for North America and Western Europe, we find that habit persistence lowers welfare gains of financial integration by about 40-50 %.

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Bibliographic Info

Paper provided by Department of Economics, Norwegian University of Science and Technology in its series Working Paper Series with number 0102.

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Length: 29 pages
Date of creation: 01 Jul 2001
Date of revision:
Publication status: Forthcoming in Journal of International Money and Finance
Handle: RePEc:nst:samfok:0102

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Web page: http://www.svt.ntnu.no/iso/WP/wp.htm
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Keywords: Habit formation; financial integration; growth; welfare;

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References

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  1. Eric van Wincoop, 1998. "How big are potential welfare gains from international risksharing?," Staff Reports 37, Federal Reserve Bank of New York.
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  16. 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.
  17. Wincoop, Eric van, 1994. "Welfare gains from international risksharing," Journal of Monetary Economics, Elsevier, vol. 34(2), pages 175-200, October.
  18. Campbell, John Y., 1999. "Asset prices, consumption, and the business cycle," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 19, pages 1231-1303 Elsevier.
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Cited by:
  1. Arjen Siegmann, 2003. "Shortfall allowed: loss aversion and habit formation," WO Research Memoranda (discontinued) 741, Netherlands Central Bank, Research Department.

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