A Heterogeneous-Agent Foundation of the Representative-Agent Approach

Sabine Elmiger
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Sabine Elmiger: University of Zurich and Swiss Finance Institute

No 16-58, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: The representative-agent approach is widely used in consumption-based asset pricing. From a theoretical point of view, quite restrictive assumptions on the underlying economy are needed for asset prices to depend only on aggregate consumption. A heterogeneous-agent financial market model is presented with all investors following simple rebalancing rules where aggregation already fails. A meaningful specification of a representative agent is still possible: Instead of asset prices per se the representative agent indicates the direction in which relative asset prices tend to in expectation from one time period to the next. The objective function of the representative agent is independent of the set of rebalancing rules participating in the market.

Pages: 41 pages
Date: 2016-09
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