Dynamic Asset Pricing with Interactions between Short-Sale and Borrowing Constraints

Multiplicity in general financial equilibrium with portfolio constraints

Lei Shi and Yajun Xiao

The Review of Asset Pricing Studies, 2021, vol. 11, issue 4, 886-923

Abstract: This paper studies the joint effect of borrowing and short-sale constraints under heterogeneous beliefs and risk aversions. Although the constraints never simultaneously bind in equilibrium, interesting economics emerge in the anticipatory effects of potentially future binding constraints. In particular, the risk-free rate and Sharpe ratio experience endogenous jumps at a critical state, where two equilibria coexist. Moreover, a short-sale ban can lead to a lower stock price and higher volatility depending on the relative tightness between the constraints, and tightening the borrowing constraint during a short-sale ban can also make returns more volatile. (JEL G11, G12)

Date: 2021
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