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. Finally we also want to thank Richard Clarida, Dan O’Flaherty, Rajnish Mehra, Bruce Preston, Stijn Van Nieuwerburgh, and conference participants of the 2005 Financial Management Association. Part of this research was supported by the Department of Economics, Columbia University and the Bert W. Wasserman Department of Economics and Finance, Baruch College. Christos Giannikos acknowledges the support of Baruch College Fund. Amadeu DaSilva and Mira Farka acknowledge the support of California State University Fullerton, Faculty Development Research Grant Program. Correspondence: Christos Giannikos.
Habit Formation in an Overlapping Generations Model with Borrowing Constraints
Article first published online: 7 DEC 2009
© 2009 Blackwell Publishing Ltd
European Financial Management
Volume 17, Issue 4, pages 705–725, September 2011
How to Cite
DaSilva, A., Farka, M. and Giannikos, C. (2011), Habit Formation in an Overlapping Generations Model with Borrowing Constraints. European Financial Management, 17: 705–725. doi: 10.1111/j.1468-036X.2009.00523.x
- Issue published online: 7 DEC 2009
- Article first published online: 7 DEC 2009
- equity premium puzzle;
- overlapping generations model;
- habit formation;
- risk aversion
We introduce habit-formation in the three-period OLG borrowing-constrained framework of Constantinides et al. (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 US data for relatively small levels of risk aversion.