Essays on consumption with habit formation

The aim of this thesis is to examine the implications of habit formation in a consumption-saving model with income uncertainty. By introducing habit formation, we have shown that habit formation itself leads to prudent behavior, in addition to the usual precautionary saving motive against income uncertainty.;We have shown that with habit formation, even in the quadratic case where the precautionary saving premium is zero, there is habits-induced saving. In the exponential case, we have obtained a closed form solution for consumption, which will provide a better framework for empirically testing the behavior of consumption over the business cycle. By allowing habit-forming preferences in consumption, we did not need to assume higher levels of income uncertainty to explain the excess sensitivity, the excess smoothness and the excess growth puzzles of consumption. We have also shown that the greater is the strength of habit formation the lower is the effect of income uncertainty on consumption.;By introducing liquidity constraints into the model with habit formation, we have shown that the effects of present and future shadow prices of liquidity constraint will be present and rise with the strength of habit formation.;In a consumption-leisure choice model with a Cobb-Douglas utility function and habit formation in consumption, the intertemporal marginal rate of substitution between consumption and leisure and the intertemporal marginal rate of substitution of leisure are higher the higher is the strength of habit formation. This result implies that the individual is less willing to intertemporally substitute current leisure with future leisure and with current consumption. With the liquidity constraints depending on wage earnings, the intratemporal marginal rate of substitution between consumption and leisure decreases whenever the constraint binds.;Finally, in a two-period model, we have shown that habit formation leads to a larger prudence premium and greater precautionary saving, provided that the individual has decreasing absolute prudence. However, we have found that it is not possible to conclude, even with the utility function exhibiting a simple form of habit formation, that habits increase or decrease the precautionary premium "in the sense of Kimball" when there exists multiple periods.