Habit Formation Heterogeneity: Implications for Aggregate Asset Pricing
Posted: 12 Jun 2012 Last revised: 7 Dec 2013
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Habit Formation Heterogeneity: Implications for Aggregate Asset Pricing
Habit Formation Heterogeneity: Implications for Aggregate Asset Pricing
Habit Formation Heterogeneity: Implications for Aggregate Asset Pricing
Date Written: December 6, 2013
Abstract
We explicitly solve for the aggregate asset prices in a general equilibrium Lucas endowment economy with two agents who are heterogeneous in their time-nonseparable preferences. Time-nonseparability is modeled either as internal or external habit preferences. Equilibrium quantities -- equity premium, equity return volatility, Sharpe ratio, interest rate, interest rate volatility, and asset holdings -- are computed via an algorithm of Dumas and Lyasoff (2012) modified for time-nonseparability induced by habit. We obtain that internal habits provide for a considerable improvement in obtaining aggregate asset pricing quantities consistent with historically observed magnitudes as opposed to "catching up with Joneses" preferences.
Keywords: asset pricing, consumption-based asset pricing models, external habit, internal habit, heterogeneity, time-nonseparability, general equilibrium, recursive solution
JEL Classification: C68, D58, D91, E21, E44, G11, G12
Suggested Citation: Suggested Citation
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