Habit Persistence and International Comovements

Published: 20/5/2010
Publication Working Papers
Issue W - 23
Authors Alexandre Dmitriev and Ivo Krznar
Date April 2010
JEL E32, F41, G15
ISSN 1334-0131

Keywords

international real business cycles, time nonseparable preferences, habit persistence, investment comovements

Summary

Two-country real business cycle models with time-separable preferences and complete markets predict that cross-country investment correlations are negative. The opposite is true in the data. Backus et al (1995) coined the term quantity anomaly for this phenomenon. This paper proposes to address this discrepancy by allowing the nonseparability of preferences over time. We incorporate internal habit formation in consumption. Our model predicts empirically plausible values of cross-country investment correlation without deteriorating other business cycle statistics. The results are robust to the degree of spillovers and persistence in the specification of productivity shocks.