Chabakauri, Georgy (2010) Asset pricing with heterogeneous investors and portfolio constraints. Working paper series, London School of Economics and Political Science, London, UK.
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We evaluate the impact of portfolio constraints on financial markets in a dynamic equilibrium pure exchange economy with one consumption good and two CRRA investors that may differ in risk aversions, beliefs regarding the dividend process and portfolio constraints. Despite numerous applications, portfolio constraints are notoriously difficult to incorporate into dynamic equilibrium analysis without the restrictive assumption of logarithmic preferences. We provide a tractable solution method that yields new insights on the asset pricing implications of portfolio constraints such as limited stock market participation, margin requirements and short sales prohibition without restricting risk aversion parameters. We demonstrate that in a setting where one investor is unconstrained while the other faces an upper bound constraint on the proportion of wealth that can be invested in stocks the model generates countercyclical market prices of risk and stock return volatilities, procyclical price-dividend ratios, excess volatility and other patterns consistent with empirical findings. In a setting with margin requirements we demonstrate that under plausible parameters tighter constraints decrease stock return volatilities during the times when the constraints are likely to bind.
|Item Type:||Monograph (Working Paper)|
|Additional Information:||© 2011 The Author|
|Uncontrolled Keywords:||asset pricing, dynamic equilibrium, heterogeneous investors, portfolio constraints, stock return volatility|
|Library of Congress subject classification:||H Social Sciences > HG Finance|
|Journal of Economic Literature Classification System:||D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
|Sets:||Departments > Finance|
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