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Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model

Harald Uhlig

SFB 649 Discussion Papers from Humboldt University, Collaborative Research Center 649

Abstract: In this paper, I investigate the scope of a model with exogenous habit formation - or `catching up with the Joneses`, see Abel (1990) - to generate the observed equity premium as well as other key macroeconomic facts. Along the way, I derive restrictions for four out of eight parameters for a rather general preference specification of habit formation by imposing consistency with long-run growth, the leisure share, the aggregate Frisch elasticity of labor supply, the observed risk-free rate, and the observed Sharpe ratio. I show that a DSGE model with (exogenous and lagged) habits in both leisure and consumption, but not necessarily with additional persistence, is well capable of matching the observed asset market facts as well as macro facts, provided one allows for moderate real wage stickiness and provided one allows for sufficient curvature on preferences, as dictated by the asset market observations. Without wage stickiness, delivery on both the asset pricing implications as well as the macroeconomic implications seems to be much harder.

Keywords: asset pricing; wage rigidity; habit formation; Frisch elasticity; Sharpe ratio; log-linear approximation (search for similar items in EconPapers)
JEL-codes: E24 E30 G12 (search for similar items in EconPapers)
Pages: 15 pages
Date: 2007-05
New Economics Papers: this item is included in nep-dge, nep-lab and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (104)

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Related works:
Journal Article: Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model (2007) Downloads
Working Paper: Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model (2007) Downloads
Working Paper: Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model (2007) Downloads
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