Solving Models with External Habit

27 Pages Posted: 28 Sep 2005 Last revised: 3 Aug 2010

See all articles by Jessica A. Wachter

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Date Written: August 2005

Abstract

Habit utility has been the focus of a large and growing body of literature in financial economics. This study investigates ways of accurately and efficiently solving the Campbell and Cochrane (1999) external habit model. Solutions for this model based on a grid of values for the state variable are shown to converge as the grid becomes increasingly fine. Convergence is substantially faster if the price-dividend ratio is computed as a series of ``zero-coupon equity'' claims rather than as the fixed-point of the Euler equation. Fitting the model to the term structure as well as to equity moments (as in Wachter (2005)) also results in faster convergence.

Suggested Citation

Wachter, Jessica A., Solving Models with External Habit (August 2005). NBER Working Paper No. w11559, Available at SSRN: https://ssrn.com/abstract=788424

Jessica A. Wachter (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
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National Bureau of Economic Research (NBER)

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