Asset Prices under Habit Formation and Catching up with the Joneses
Andrew B. Abel
This paper introduces a utility function that nests three classes
of utility functions: (1) time-separable utility functions; (2)
"catching up with the Joneses" utility functions that depend on the
consumer's level of consumption relative to the lagged cross-sectional
average level of consumption; and (3) utility functions that display
habit formation. Closed-form solutions for equilibrium asset prices are
derived under the assumption that consumption growth is i.i.d. The
equity premia under catching up with the Joneses and under habit
formation are, for some parameter values, as large as the historically
observed equity premium in the United States.
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