Business Cycle and Asset Prices: A Computable General Equilibrium Analysis with Agency Costs and Habit Formation

Abstract

For the purpose of explaining both business cycles and asset returns, we examine a real business cycle (RBC) model with habit-augmented preferences and endogenous costs of adjusting the capital stock. Following the agencycost model of Carlstrom and Fuerst (1997), capital adjustment costs are affected by the level of entrepreneur’s net worth such that an increase in net worth (following a positive productivity shock) lowers agency costs associated with external …nancing, and hence makes it easier to expand the capital stock. Along with the restricted labor supply, the model resolves the asset pricing puzzles of the consumption-based model in the sense that the implied stochastic discount factor (or pricing kernel) reaches the Hansen-Jagannathan (1991)