Saving and Habit Formation: Evidence from Dutch Panel Data

This paper focuses on the role of habit formation in individual preferences over consumption and saving.We closely relate to Alessie and Lusardi's (1997) model as we estimate a model which is based on their closed-form solution, where saving is expressed as a function of lagged saving and other regressors. Alternatively, we could use an Euler-equation approach (see e.g.Guariglia and Rossi (2001) and Dynan (2000)), but we will argue that this approach may yield spuriously negative estimates of the habit formation parameter because in surveys consumption is typically measured with considerable error.A second reason to use the closed form solution as a basis of the empirical model is that it embodies more information about the habit formation model than the Euler equation.Therefore, the closed form solution allows for a more powerful test of the validity of the habit formation model than the Euler equation approach.