Habits and Leverage

Pietro Veronesi and Tano Santos

No 11681, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Many stylized facts of leverage, trading, and asset prices follow from a frictionless general equilibrium model that features agents’ heterogeneity in endowments and habit preferences. Our model predicts that aggregate debt increases in good times when stock prices are high, return volatility is low, and levered agents enjoy a “consumption boom.†Our model is consistent with poorer agents borrowing more and with recent evidence on intermediaries’ leverage being a priced factor of asset returns. In crisis times, levered agents strongly deleverage by “fire selling†their risky assets as asset prices drop. Yet, consistently with the data, their debt-to-wealth ratios increase because their wealth decline faster due to higher discount rates.

Date: 2016-12
New Economics Papers: this item is included in nep-ban and nep-dge
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