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Consumption paths under prospect utility in an optimal growth model

  • Foellmi, Reto
  • Rosenblatt-Wisch, Rina
  • Schenk-Hoppé, Klaus Reiner

This paper studies the Cass-Koopmans-Ramsey model of optimal economic growth in the presence of loss aversion and habit formation. The representative agent's preferences for consumption can be gradually varied between the standard constant intertemporal elasticity of substitution (CIES) case and Kahneman and Tversky's prospect utility. We find that the transitional dynamics of optimal consumption paths differ distinctly from the standard model, in particular consumption smoothing is more pronounced. We also show that prospect utility can cause the economy to remain in a steady state with low consumption and low capital.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 3 (March)
Pages: 273-281

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:3:p:273-281
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  17. Surico, Paolo, 2007. "The Fed's monetary policy rule and U.S. inflation: The case of asymmetric preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 305-324, January.
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  19. 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.
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