Many asset pricing puzzles can be explained when habit formation is added to standard preferences. We show that utility functions with a habit then gives rise to a puzzle of consumption volatility in place of the asset pricing puzzles when agents can choose consumption and labor optimally in response to more fundamental shocks. We show that the consumption reaction to technology shocks are too small by an order of magnitude when a utility includes a consumption habit. Moreover, once a habit in leisure is included, labor input is counterfactually smooth over the cycle. In the case of habit in both consumption and leisure, labor input is even countercyclical. Consumption continues to be too smooth. (Copyright: Elsevier)
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.
Volume (Year): 3 (2000) Issue (Month): 1 (January) Pages: 79-99 Download reference. The following formats are available: HTML
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Find related papers by JEL classification: E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
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