infonet-economy

This paper explores the expressive ability of the external habit mechanism. I show that whenever the stochastic discount factor (SDF) is a function of aggregate consumption, there exists a representative agent external habit model that replicates that SDF. I also show that within this framework the other utility function parameters become indeterminate, in that a different choice of power utility can lead to the exact same SDF. The indeterminacy arises from an ambiguity in the SDF between the externality and individual consumption.