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We analyze the prices of derivative securities in response to the changes in the parameters characterizing investors’ internal and external habits. Using a multiplicative specification for preferences, we solve for the equilibrium allocation with a second order approximation of the policy function. We recover the prices of the derivatives and we characterize their response to changes in the duration and the intensity of internal and external habits separately. We show that there is a monotonic relation between the duration parameter and the forward and options’ price under both types of habits. The effect of the intensity parameter however, depends of the level on the duration and on the particular habit that is analyzed.
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