Habit formation and housing over the life cycle

Abstract

We explore the role of habit formation in housing in explaining the life-cycle household allocations. Empirical studies about households in the U.S. reveal that the housing profile increases monotonically until age mid-60s and then flattens out. The model is realistically calibrated and solved numerically under different habit strength parameters. For all values of the parameter, our model produces lower reduction of housing for the elderly compared to the standard model which does not include habit formation. The amount of reduction in housing in the old ages and the level of housing decrease significantly as habit strength increases. The person becomes more attached to his house with a higher habit strength. Considering intolerance towards housing reductions, one consumes a lower amount of housing in the young ages to be able to maintain it in the old ages. These results suggest that in addition to the transaction costs in house trading, habit formation in housing also has a merit in explaining the preservation of housing for elderly people. Our model improves on the literature by investigating the effects of a habit formation behind household allocations and by reducing the role of transaction costs in solving the housing puzzle of the elderly. It contributes to the literature by using a new model with a deep habit preference form and housing. Our model should be preferred to the existing ones since it provides a richer and more real framework for modeling households.