Heterogeneous Preferences and Asset Pricing

In this paper , we present an equilibrium model of asset pricing. The basic model considers a production economy of two classes of investors with habits formations: one class have "internal habit" which habit depends on an agent\´s own consumption and the agent takes account of this when choosing how much to consume; the other class have "external habit", which habit depends on aggregate consumption that is unaffected by any one agent\´s decisions. We use the model to examine the effect of preference heterogeneity on asset pricing. We find that in generally , internal habit increase the equity premium while external habit effect on equity premium dependent on the correlation between habits level and risk assets.