TY  - JOUR
AU  - Ljungqvist,Lars
AU  - Uhlig,Harald
TI  - Optimal Endowment Destruction under Campbell-Cochrane Habit Formation
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 14772
PY  - 2009
Y2  - March 2009
UR  - http://www.nber.org/papers/w14772
L1  - http://www.nber.org/papers/w14772.pdf
N1  - Author contact info:
Lars Ljungqvist
Stockholm School of Economics
Sveavagen 65
SE-113 83 Stockholm
SWEDEN
E-Mail: Lars.Ljungqvist@hhs.se

Harald Uhlig
Dept. of Economics
University of Chicago
1126 E 59th Street
Chicago, IL 60637
Tel: 773/702-3702
Fax: 773/702-8490
E-Mail: huhlig@uchicago.edu
AB  - Campbell and Cochrane (1999) formulate a model that successfully explains a wide variety of asset pricing puzzles, by augmenting the standard power utility function with a time-varying subsistence level, or "external habit", that adapts nonlinearly to current and past average consumption in the economy. This paper demonstrates, that this comes at the "price" of several unusual implications. For example, we calculate that a society of agents with the preferences and endowment process of Campbell and Cochrane (1999) would experience a welfare gain equivalent to a permanent increase of nearly 16% in consumption, if the government enforced one month of fasting per year, reducing consumption by 10 percent then.  We examine and explain these features of the preferences in detail.  We numerically characterize the solution to the social planning problem.  We conclude that Campbell-Cochrance preferences will provide for interesting macroeconomic modeling challenges, when endogenizing aggregate consumption choices and government policy.
ER  -