Consumption Complementarities Research Articles

Habit Formation: A Resolution of the Equity Premium Puzzle

The equity premium puzzle, identified by Mehra and Prescott, states that, for plausible values of the risk aversion coefficient, the difference of the expected rate of return on the stock market and the riskless rate of interest is too large, given the observed small variance of the growth rate in per capita consumption. The puzzle is resolved in the context of an economy with rational expectations once the time separability of von Neumann-Morgenstern preferences is relaxed to allow for adjacent complementarity in consumption, a property known as habit persistence. Essentially habit persistence drives a wedge between the relative risk aversion of the representative agent and the intertemporal elasticity of substitution in consumption.

On Governing Multilateral Transactions with Bilateral Contracts

Bilateral contracts, while neither negotiated nor enforced in an integrated way, are nevertheless often interrelated both economically and strategically owing to production or consumption complementarities and to asymmetric information. A set of bilateral contracts forms a mechanism with special properties. This mechanism forms a contract equilibrium if there is no joint incentive for a supplier and any individual customer unilaterally to alter the terms of their contract. If agents' preferences are risk neutral in money income, and if their private information is independent, then there exists a contract equilibrium that implements efficient transactions. If, in addition, preferences are strictly concave and differentiable in goods and services, and technologically feasible sets are suitably convex, then this equilibrium is essentially unique.