A mean field game approach to equilibrium consumption under external habit formation

TL;DR

This paper models equilibrium consumption with external habit formation in large populations using mean field games, deriving explicit equilibrium strategies and analyzing their financial implications.

Contribution

It introduces a mean field game framework for external habit formation, providing explicit equilibrium solutions and convergence analysis for large-agent systems.

Findings

Explicit mean field equilibrium strategies derived

Convergence order of approximate Nash equilibria established

Financial implications of consumption habits analyzed

Abstract

This paper studies the equilibrium consumption under external habit formation in a large population of agents. We first formulate problems under two types of conventional habit formation preferences, namely linear and multiplicative external habit formation, in a mean field game framework. In a log-normal market model with the asset specialization, we characterize one mean field equilibrium in analytical form in each problem, allowing us to understand some quantitative properties of the equilibrium strategy and conclude some financial implications caused by consumption habits from a mean-field perspective. In each problem with n agents, we construct an approximate Nash equilibrium for the n-player game using the obtained mean field equilibrium when n is sufficiently large. The explicit convergence order in each problem can also be obtained.