Utility Function and Optimum Consumption in the models with Habit Formation and Catching up with the Joneses

Details Utility Function and Optimum Consumption in the models with Habit Formation and Catching up with the Joneses Utility Function and Optimum Consumption in the models with Habit Formation and Catching up with the Joneses

2009-09-20

arxiv.org/abs/0909.3655v1

Economy

Quantitative Finance

General Finance

11 pages, 7 figures

Scientific paper

This paper analyzes popular time-nonseparable utility functions that describe "habit formation" consumer preferences comparing current consumption with the time averaged past consumption of the same individual and "catching up with the Joneses" (CuJ) models comparing individual consumption with a cross-sectional average consumption level. Few of these models give reasonable optimum consumption time series. We introduce theoretically justified utility specifications leading to a plausible consumption behavior to show that habit formation preferences must be described by a power CRRA utility function different from the exponential CARA used for CuJ.

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