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Solving Models with External Habit

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  • Jessica A. Wachter

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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11559.

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Date of creation: Aug 2005
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Publication status: published as Wachter, Jessica A. "Solving Models With External Habit," Finance Research Letters, 2005, v2(4,Dec), 210-226.
Handle: RePEc:nbr:nberwo:11559

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Cited by:
  1. Lustig, Hanno & van Nieuwerburgh, Stijn & Verdelhan, Adrien, 2012. "The Wealth-Consumption Ratio," CEPR Discussion Papers 9022, C.E.P.R. Discussion Papers.
  2. Jaroslav Borovička & Mark Hendricks & José A. Scheinkman, 2011. "Risk-Price Dynamics," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 9(1), pages 3-65, Winter.
    • Lars Peter Hansen & Jaroslav Borovicka & Mark Hendricks & Jose A. Scheinkman, 2010. "Risk Price Dynamics," Working Papers 2010-004, Becker Friedman Institute for Research In Economics.
    • Jaroslav Borovička & Lars Peter Hansen & Mark Hendricks & José A. Scheinkman, 2009. "Risk Price Dynamics," NBER Working Papers 15506, National Bureau of Economic Research, Inc.
  3. Møller, Stig Vinther, 2009. "Habit persistence: Explaining cross-sectional variation in returns and time-varying expected returns," Journal of Empirical Finance, Elsevier, vol. 16(4), pages 525-536, September.
  4. Hanno Lustig & Stijn Van Nieuwerburg & Adrien Verdelhan, 2007. "The Wealth-Consumption Ratio: A Litmus Test for Consumption-based Asset Pricing Models¤," Boston University - Department of Economics - Working Papers Series WP2007-030, Boston University - Department of Economics.
  5. Christopher J. Neely & David E. Rapach & Jun Tu & Guofu Zhou, 2010. "Out-of-sample equity premium prediction: economic fundamentals vs. moving-average rules," Working Papers 2010-008, Federal Reserve Bank of St. Louis.
  6. Jianfeng Yu, 2012. "Using Long-Run Consumption-Return Correlations to Test Asset Pricing Models," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(3), pages 317-335, October.
  7. Mele, Antonio, 2007. "Asymmetric stock market volatility and the cyclical behavior of expected returns," Journal of Financial Economics, Elsevier, vol. 86(2), pages 446-478, November.
  8. Yu Chen & Thomas Cosimano & Alex Himonas, 2010. "Continuous time one-dimensional asset-pricing models with analytic price–dividend functions," Economic Theory, Springer, vol. 42(3), pages 461-503, March.
  9. Bach, Christian & Møller, Stig V., 2011. "Habit-based asset pricing with limited participation consumption," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 2891-2901, November.
  10. Lars Ljungqvist & Harald Uhlig, 2009. "Optimal Endowment Destruction under Campbell-Cochrane Habit Formation," NBER Working Papers 14772, National Bureau of Economic Research, Inc.
  11. Lars Peter Hansen, 2008. "Modeling the Long Run: Valuation in Dynamic Stochastic Economies," NBER Working Papers 14243, National Bureau of Economic Research, Inc.

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