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Incomplete markets, precautionary savings, labor supply
Incomplete Markets;Labor Supply;Precautionary Savings
Incomplete Markets; Precautionary Savings; Labor Supply
Habit formation has been proposed as a possible solution to the equity premium puzzle. This paper extends the class of models that support the habits explanation in order to account for heterogeneity in earnings, wealth, habits, and consumption. I find that habit formation does indeed increase the equity premium. However, contrary to earlier results, the habit hypothesis does not imply a price for risk as large as the one measured in the data. There are three reasons for this. First, households in a habits economy modify their consumption/savings decision. Second, they modify their portfolio choice. These two changes in behavior diminish the consumption fluctuations faced by households. Third, the composition of the set of agents pricing risk in the economy changes so that relatively better self-insured households end up pricing risk. ...
Income tax, policy reform, heterogeneous agents, general equilibrium.
working hours, wage inequality, unemployment, search, human capital filtering
Flat-tax reforms, Efficiency, Inequality, Earnings distribution, Income distribution
Heterogeneity, Health Status, Health Related Behavior, Human Capital
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