Comparative Statics of Asset Prices

Theodoros Diasakos

No 72, Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: In a single-commodity, pure-exchange, representative-agent economy with many Lucas' trees whose dividends are geometric Brownian motions, I study the comparative statics of the prices of these assets with respect to the current Brownian realization. As is well-known, due to wealth effects, a security's price may vary with the realization of a Brownian motion even when its dividend is independent of it. Yet, a crucial component of wealth effects has hitherto been ignored by the literature: changes in wealth do not alter only the agent's risk aversion, but also her perceived "riskiness" of the security. This enhances the extent to which market-clearing leads to endogenously-generated correlation across asset prices and returns, over and above that induced by correlation between payoffs, giving the appearance of "contagion." I establish also a necessary and sufficient condition for the securities market to be dynamically complete. Being independent of the utility function of the representative agent, it applies even in the presence of many heterogenous agents.

Keywords: General Equilibrium; Comparative Statics; Contagion; Dynamically Complete Markets (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
Pages: 84 pages
Date: 2008, Revised 2011
New Economics Papers: this item is included in nep-dge
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