Revisiting asset pricing under habit formation in an overlapping-generations economy

Sei Wan Kim, Joshua Krausz, Kiseok Nam

Research output: Contribution to journalArticlepeer-review

5 Scopus citations

Abstract

By incorporating habit formation into an overlapping-generations economy, we show that the middle-aged consumers' savings decision has a substantial impact on the equity premium. The higher incentive for savings for the middle-aged, resulting from the habit formation preference, causes an even higher demand for bonds and a lower demand for equity, which eventually generates a lower risk-free rate and a higher required return for holding equity than does the framework of non-habit forming models. Calibration results verify that the habit formation setting, together with an OLG framework is capable of yielding lower bond returns and higher equity returns than the standard CRRA utility models, and the borrowing constraint imposed on the young-aged consumers amplifies the positive effect of habit formation on the equity premium. The findings imply that habit formation preferences within the overlapping-generations framework under the borrowing-constrained economy can provide a more improved explanation of the equity premium puzzle.

Original languageEnglish
Pages (from-to)132-138
Number of pages7
JournalJournal of Banking and Finance
Volume37
Issue number1
DOIs
StatePublished - Jan 2013

Keywords

  • Calibration
  • Consumption asset pricing model
  • Equity premium
  • Habit formation preference
  • Overlapping-generations economies

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