HABIT PERSISTENCE AND WELFARE GAINS FROM INTERNATIONAL ASSET TRADE
We introduce habit formation in a model that studies the link between
international trade in financial assets, economic growth, and welfare.
As with time separable preferences asset trade increases the mean growth
rate, but it also increases growth-volatility. We demonstrate that the
welfare gain from asset trade is lower with habit persistence in consumption.
This reflects that the habit-forming households perceive the higher growth-volatility
as a higher cost to obtain increased average growth. Calibrating the model
to data for North America and Western Europe, we find that habit persistence
lowers welfare gains of financial integration
by about 40-50 %.