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The Economic Research Institute, Stockholm School of Economics SSE/EFI Working Paper Series in Economics and Finance

No 337:
On Consumption Bunching under Campbell-Cochrane Habit Formation

Lars Ljungqvist () and Harald Uhlig ()

Abstract: Campbell and Cochrane (1999) propose a preference specification that can explain a wide variety of asset pricing puzzles such as the high equity premium. They augment the basic power utility function with a time-varying subsistence level, or "habit", which is in the spirit of "catching up with the Joneses" but with a novel nonlinear mapping of consumption into habit. This paper demonstrates a surprising implication of the Campbell-Cochrane preference specification: consumption bunching is desirable.

Keywords: Catching-up-with-the-Joneses preferences; habit; consumption bunching; (follow links to similar papers)

JEL-Codes: E21; (follow links to similar papers)

12 pages, October 22, 1999

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