Habit Formation Heterogeneity : Implications for Aggregate Asset Pricing

We explicitly solve for the aggregate asset prices in a general equilibrium Lucas endowment economy with two agents who are heterogeneous in their time-nonseparable preferences. Time-nonseparability is modeled either as internal or external habit preferences. Equilibrium quantities -- equity premium, equity return volatility, Sharpe ratio, interest rate, interest rate volatility, and asset holdings -- are computed via an algorithm of Dumas and Lyasoff (2012) modified for time-nonseparability induced by habit. We obtain that internal habits provide for a considerable improvement in obtaining aggregate asset pricing quantities consistent with historically observed magnitudes as opposed to "catching up with Joneses" preferences