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Asset Prices in an Exchange Economy with Habit Formation

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  • Detemple, Jerome B
  • Zapatero, Fernando

Abstract

This paper analyzes asset prices in a representative agent exchange economy with habit-forming preferences. For a general class of utility indices and endowment processes, the authors characterize the optimal demand for consumption and derive explicit solutions for the interest rate and asset risk premia. They show that consumption smoothness may obtain even when the interest rate is stochastic. The consumption capital asset pricing model may not hold when the endowment process has stochastic coefficients; asset risk premia are larger under mild assumptions. The interest rate depends on the growth in the standard of living. Malliavin calculus is employed in the analysis. Copyright 1991 by The Econometric Society.

Suggested Citation

  • Detemple, Jerome B & Zapatero, Fernando, 1991. "Asset Prices in an Exchange Economy with Habit Formation," Econometrica, Econometric Society, vol. 59(6), pages 1633-1657, November.
  • Handle: RePEc:ecm:emetrp:v:59:y:1991:i:6:p:1633-57
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    References listed on IDEAS

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    1. repec:adr:anecst:y:1988:i:9:p:04 is not listed on IDEAS
    2. J. S. Flemming, 1969. "The Utility of Wealth and the Utility of Windfalls," Review of Economic Studies, Oxford University Press, vol. 36(1), pages 55-66.
    3. Eichenbaum, Martin & Hansen, Lars Peter, 1990. "Estimating Models with Intertemporal Substitution Using Aggregate Time Series Data," Journal of Business & Economic Statistics, American Statistical Association, pages 53-69.
    4. Harrison, J. Michael & Taylor, Allison J., 1978. "Optimal control of a Brownian storage system," Stochastic Processes and their Applications, Elsevier, pages 179-194.
    5. Grossman, S J & Melino, Angelo & Shiller, Robert J, 1987. "Estimating the Continuous-Time Consumption-Based Asset-Pricing Model," Journal of Business & Economic Statistics, American Statistical Association, pages 315-327.
    6. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-265, April.
    7. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, pages 247-257.
    8. N. Gregory Mankiw & Matthew D. Shapiro, 1984. "Risk and Return: Consumption versus Market Beta," NBER Working Papers 1399, National Bureau of Economic Research, Inc.
    9. George M. Constantinides, 2005. "Capital Market Equilibrium with Transaction Costs," World Scientific Book Chapters,in: Theory Of Valuation, chapter 7, pages 207-227 World Scientific Publishing Co. Pte. Ltd..
    10. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October.
    11. Bernanke, Ben, 1985. "Adjustment costs, durables, and aggregate consumption," Journal of Monetary Economics, Elsevier, pages 41-68.
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