Is the Volatility of the Market Price of Risk due to Intermittent Portfolio Re-balancing?

YiLi Chien, Harold Cole () and Hanno Lustig ()

No 15382, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Our paper examines whether intermittent portfolio re-balancing on the part of some stock market investors can help to explain the counter-cyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up an incomplete markets model in which CRRA-utility investors are subject to aggregate and idiosyncratic shocks and have heterogeneous trading technologies. In our model, a large mass of passive investors do not re-balance their portfolio shares in response to aggregate shocks, while a smaller mass of active investors adjust their portfolio each period to respond to changes in the investment opportunity set. We find that intermittent re-balancers amplify the effect of aggregate shocks on the time variation in risk premia by a factor of three in a calibrated version of our model.

JEL-codes: G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec and nep-pke
Date: 2009-09
Note: AP EFG

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