Solving Models with External Habit / Jessica A. Wachter.

By:

Wachter, Jessica A

Contributor(s):

National Bureau of Economic Research

Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w11559.Publication details: Cambridge, Mass. National Bureau of Economic Research 2005.Description: 1 online resource: illustrations (black and white)Subject(s):

G1 - General Financial Markets

Online resources:

Available additional physical forms:

Hardcopy version available to institutional subscribers

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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August 2005.

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.