Habit Formation Heterogeneity: Implications for Aggregate Asset Pricing
38 Pages Posted: 16 Sep 2012 Last revised: 15 Aug 2017
Date Written: August 14, 2017
We explicitly solve for the aggregate asset prices in a discrete-time general-equilibrium endowment economy with two agents who differ with respect to their preferences for risk aversion and sensitivity to habit, either internal or external. We compute equilibrium quantities -- equity premium, equity return volatility, Sharpe ratio, interest rate, interest rate volatility, and asset holdings -- via a generalized algorithm of Dumas and Lyasoff (2012, JF). Generalization addresses time-nonseparability of utility function induced by habit. We find that internal habits produce equilibrium asset prices that are more consistent with historically observed aggregate prices relative to external-habit preferences.
Keywords: 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
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