Title: Consumption commitments
Subtitle: neoclassical foundations for habit formation
Description: "This paper studies consumption and portfolio choice in a model where agents have neoclassical preferences over two consumption goods, one of which involves a commitment in that its consumption can only be adjusted infrequently.  Aggregating over a population of such agents implies dynamics identical to those of a representative consumer economy with habit formation utility.  In particular, aggregate consumption is a slow-moving average of past consumption levels, and risk aversion is amplified because the marginal utility of wealth is determined by excess consumption over the prior commitment level.  We test the model's prediction that commitments amplify risk aversion by using home tenure (years spent in current house) as a proxy for commitment: Recent home purchasers are unlikely to move in the near future, and are therefore more constrained by their housing commitment.  We use a set of control groups to establish that the timing of marital shocks such as marriage and divorce can be used to create exogenous variation in home tenure conditional on age and wealth.  Using these marital shocks as instruments, we find that the average investor reallocates $1,500 from safe assets to stocks per year in a house.  Hence, recent home purchasers have highly amplified risk aversion, suggesting that real commitments are a quantitatively powerful source of habit-like behavior"--National Bureau of Economic Research web site.
Subjects: Mathematical models, Consumption (Economics)