Habit Formation Heterogeneity: Implications for Aggregate Asset Pricing

38 Pages Posted: 17 Dec 2011 Last revised: 11 Jun 2012

See all articles by Olesya V. Grishchenko

Olesya V. Grishchenko

Board of Governors of the Federal Reserve System

Eduard Dubin

Goethe University Frankfurt - Department of Finance

Vasily Kartashov

Goethe University Frankfurt

Multiple version iconThere are 4 versions of this paper

Date Written: March 1, 2012

Abstract

We explicitly solve for the aggregate asset pricing quantities of a general equilibrium Lucas endowment economy inhabited by two agents with habit formation preferences. Preferences are modeled either as internal or external habits. We allow for agents' heterogeneity in relative risk aversion and habit strength. Equilibrium quantities, such as equity premium, equity volatility, Sharpe ratio, interest rate volatility, and asset holdings are computed using a recently developed algorithm of Dumas and Lyasoff (2012). The algorithm is refined to capture 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

Grishchenko, Olesya V. and Dubin, Eduard and Kartashov, Vasily, Habit Formation Heterogeneity: Implications for Aggregate Asset Pricing (March 1, 2012). Available at SSRN: https://ssrn.com/abstract=1973642 or http://dx.doi.org/10.2139/ssrn.1973642

Olesya V. Grishchenko (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-452-2981 (Phone)

Eduard Dubin

Goethe University Frankfurt - Department of Finance ( email )

House of Finance
Grueneburgplatz 1
Frankfurt am Main, Hessen 60323
Germany

Vasily Kartashov

Goethe University Frankfurt ( email )

Gr├╝neburgplatz 1
Frankfurt am Main, 60323
Germany

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