Habit formation in an overlapping generations model with borrowing constraints (original) (raw)
We introduce habit-formation in the three-period OLG borrowing-constrained framework of Constantinides et al. (2002) by allowing the utility of the middleaged (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 US data for relatively small levels of risk aversion. We are grateful to John Donaldson for numerous comments and suggestions during the course of this research. We are especially thankful to the editor, John Doukas, and George Constantinides, the referee, for their various helpful comments and suggestions.
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