Habit Formation in an Overlapping Generations Model with Borrowing Constraints

European Financial Management, Forthcoming

36 Pages Posted: 18 Sep 2009

See all articles by Amadeu DaSilva

Amadeu DaSilva

California State University, Fullerton

Mira Farka

California State University, Fullerton

Christos I. Giannikos

CUNY - Baruch College; CUNY - The Graduate Center

Date Written: July 2009

Abstract

We introduce habit-formation in the three-period OLG borrowing-constraint framework of Constantinides, Donaldson, and Mehra (2002) by allowing the utility of the middle-aged (old) to depend on consumption when young (middle-aged). This specification enables us to separate the effect of the two habit parameters (middle-aged and old) since each representative age-group can face different levels of habit persistence. The two-habit setup underlines some important issues with regards to savings and security returns which do not always conform to the standard findings in the literature. In addition, the model produces equity premium consistent with U.S. data for relatively small levels of risk aversion.

Keywords: Equity premium puzzle, Overlapping generations model, Habit formation, Risk aversion

JEL Classification: G0, G12, D10, E21

Suggested Citation

DaSilva, Amadeu and Farka, Mira and Giannikos, Christos I., Habit Formation in an Overlapping Generations Model with Borrowing Constraints (July 2009). European Financial Management, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1474095

Amadeu DaSilva

California State University, Fullerton ( email )

800 N State College St
Fullerton, CA 92831
United States

Mira Farka (Contact Author)

California State University, Fullerton ( email )

800 N State College St
Fullerton, CA 92831
United States

Christos I. Giannikos

CUNY - Baruch College ( email )

Dept. of Eco & Fin
Box B10-225
New York, NY New York 10010
United States
646-312-3492 (Phone)
646-312-3451 (Fax)

CUNY - The Graduate Center ( email )

365 Fifth Avenue
New York,, NY 10016
United States

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