Equilibrium in securities markets with heterogeneous investors and unspanned income risk

Peter Ove Christensen, Kasper Larsen and Claus Munk

Journal of Economic Theory, 2012, vol. 147, issue 3, 1035-1063

Abstract: In a finite time horizon, incomplete market, continuous-time setting with dividends and investor incomes governed by arithmetic Brownian motions, we derive closed-form solutions for the equilibrium risk-free rate and stock price for an economy with finitely many heterogeneous CARA investors and unspanned income risk. In equilibrium, the Sharpe ratio is the same as in an otherwise identical complete market economy, whereas the risk-free rate is lower and, consequently, the stock price is higher. The reduction in the risk-free rate is highest when the more risk-averse investors face the largest unspanned income risk.

Keywords: Unspanned income; Heterogeneous preferences; Continuous-time equilibrium; Risk-free rate puzzle; Equity premium; Incomplete markets; Brownian motion (search for similar items in EconPapers)
JEL-codes: D53 G11 G12 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:147:y:2012:i:3:p:1035-1063

DOI: 10.1016/j.jet.2012.01.007

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