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Can Habit Formation be Reconciled with Business Cycle Facts?

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  • Lettau, M.

    (Tilburg University, School of Economics and Management)

  • Uhlig, H.F.H.V.S.

    (Tilburg University, School of Economics and Management)

Abstract

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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Suggested Citation

  • Lettau, M. & Uhlig, H.F.H.V.S., 1995. "Can Habit Formation be Reconciled with Business Cycle Facts?," Other publications TiSEM b152dad0-97de-48c9-bde6-6, Tilburg University, School of Economics and Management.
    • Handle: RePEc:tiu:tiutis:b152dad0-97de-48c9-bde6-6864e691a913
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    References listed on IDEAS

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    9. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-262, April.
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    More about this item

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E21 - Macroeconomics and Monetary Economics - - 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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