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Unpublished Paper
Consumption Habit Formation and Income Variability
  • Xiaoying Liu, university of pennsylvania
This paper develops a new way to estimate the consumption habit
persistence coefficient using household panel data. In contrast to
the approach of estimating an approximate Euler equation, the
identification comes from comparing the coevolution of income and
consumption. Using Spanish data from 1985 to 1995, we estimate
a joint model of habit formation and income variability. We find
habit persistence smooths the impact of permanent income shocks
on consumption. With our estimated parameters, we find habit
persistence reduces the variance of consumption by 40% over the
life-cycle. Consumption habits offers an explanation for the “excess smoothness of consumption” puzzle.
  • consumption,
  • habit persistence,
  • income variability,
  • relative risk aversion coefficient,
  • insurance
Publication Date
Citation Information
Xiaoying Liu. "Consumption Habit Formation and Income Variability" (2013)
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