Keeping Up with the Joneses: Evidence from Micro Data

This paper provides evidence that habit persistence is an important determinant of household consumption choices in a setting that allows for individual heterogeneity and credit constraints. By using actual individual consumption data, I find that the strength of the external habit, captured by the consumption of the reference group, is 0.290; while the strength of internal habit, represented by household past consumption, is 0.503. These findings provide empirical support to the theories that explain the equity premium puzzle by introducing habit persistence in the utility function. The results are robust to the inclusion of income growth rate and other measures of economic activity in the regression, changes in specification and in the instrument set. I also show that my specification subsumes the isoelastic specification used in Constantinides (1990), Abel (1990) and Campbell and Cochrane (1999) and that the strength of habit, the curvature of the utility function and the coefficient of relative risk aversion are similar to theirs. Finally, I show how incorrect aggregation and neglecting heterogeneity can explain why empirical studies of habit persistence based on aggregate consumption data and a representative agent reach mixed or negative findings. ∗I would like to thank Debbie Lucas, Kent Daniel, Bill Rogerson, Paola Sapienza and Annette Vissing-Jorgensen for long discussions, support and guidance. Special thanks go to Donald P. Jacobs and the U.S. credit card company that provided the data. I am also grateful to George Akerlof, Roc Armenter, Luca Benzoni, Paco Buera, Francesco Caselli, Colin Camerer, John Campbell, Janice Eberly, Andrea Eisfeldt, Mike Fishman, Johannes Horner, David Laibson, Ron Laschever, Annamaria Lusardi, Sendhil Mullainathan, John Panzar, Marcin Peski, Karl Schmedders, Bob McDonald, Christopher Polk, Todd Pulvino, Matthew Rabin, Marciano Siniscalchi and Costis Skiadas for valuable discussions and suggestions. I would also like to thank Patricia Ledesma for technical support. Financial support from the Northwestern University Dissertation Year Fellowship, Banca d’Italia and Fondazione Einaudi is gratefully acknowledged. All remaining errors are mine. Comments are welcome: [email protected].