A note on the exact solution of asset pricing models with habit persistence

Abstract

This paper provides a closed-form solution to a standard asset pricing model with habit formation when the growth rate of endowment follows a first-order Gaussian autoregressive process. We determine conditions that guarantee the existence of a stationary bounded equilibrium. The findings are useful because they allow to evaluate the accuracy of various approximation methods to nonlinear rational expectation models. Furthermore, they can be used to perform simulation experiments to study the finite sample properties of various estimation methods.