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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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Keywords: Habit formation; financial integration; growth; welfare;

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  1. Dumas, Bernard & Uppal, Raman, 2001. "Global Diversification, Growth, and Welfare with Imperfectly Integrated Markets for Goods," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 277-305.
  2. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  3. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
  4. Michael B. Devereux & Gregor W. Smith, 1991. "International Risk Sharing and Economic Growth," Working Papers 829, Queen's University, Department of Economics.
  5. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  6. Acemoglu, Daron & Zilibotti, Fabrizio, 1997. "Was Prometheus Unbound by Chance? Risk, Diversification, and Growth," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 709-51, August.
  7. van Wincoop, Eric, 1999. "How big are potential welfare gains from international risksharing?," Journal of International Economics, Elsevier, vol. 47(1), pages 109-135, February.
  8. Bakshi, Gurdip S. & Naka, Atsuyuki, 1997. "An empirical investigation of asset pricing models using Japanese stock market data," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 81-112, February.
  9. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
  10. A. Abel, 2010. "Asset prices under habit formation and catching up with the Jones," Levine's Working Paper Archive 1395, David K. Levine.
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  12. Maurice Obstfeld., 1993. "Risk-Taking, Global Diversification, and Growth," Center for International and Development Economics Research (CIDER) Working Papers C93-016, University of California at Berkeley.
  13. Wincoop, Eric van, 1994. "Welfare gains from international risksharing," Journal of Monetary Economics, Elsevier, vol. 34(2), pages 175-200, October.
  14. Levine, Ross, 1996. "Financial development and economic growth : views and agenda," Policy Research Working Paper Series 1678, The World Bank.
  15. Weil, Philippe, 1989. "The equity premium puzzle and the risk-free rate puzzle," Journal of Monetary Economics, Elsevier, vol. 24(3), pages 401-421, November.
  16. Svensson, Lars E. O., 1989. "Portfolio choice with non-expected utility in continuous time," Economics Letters, Elsevier, vol. 30(4), pages 313-317, October.
  17. Devereux, Michael B. & Saito, Makoto, 1997. "Growth and risk-sharing with incomplete international assets markets," Journal of International Economics, Elsevier, vol. 42(3-4), pages 453-481, May.
  18. John Y. Campbell, 1998. "Asset Prices, Consumption, and the Business Cycle," NBER Working Papers 6485, National Bureau of Economic Research, Inc.
  19. 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.
  20. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  21. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-84, March.
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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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