Risk Aversion and Optimal Portfolio Policies in Partial and General Equilibrium Economies

Raman Uppal and Leonid Kogan

No 3306, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In this article, we show how to analyse analytically the equilibrium policies and prices in an economy with a stochastic investment opportunity set and incomplete financial markets, when agents have power utility over both intermediate consumption and terminal wealth, and face portfolio constraints. The exact local comparative statistics and approximate but analytical expression for the portfolio policy and asset prices are obtained by developing a method based on perturbation analysis to expand around the solution for an investor with log utility. We then use this method to study a general equilibrium exchange economy with multiple agents who differ in their degree of risk aversion and face borrowing constraints. We characterize explicitly the consumption and portfolio policies and also the properties of asset returns. We find that the volatility of stock returns increases with the cross-sectional dispersion of risk aversion, with the cross-sectional dispersion in portfolio holdings, and with the relaxation of the constraint on borrowing. Moreover, tightening the borrowing constraint lowers the risk-free interest rate and raises the equity premium in equilibrium.

Keywords: Asset allocation; Stochastic investment opportunities; Incomplete markets; Borrowing constraints; Asymptotic analysis (search for similar items in EconPapers)
JEL-codes: D52 G11 G12 (search for similar items in EconPapers)
Date: 2002-04
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

Downloads: (external link)
https://cepr.org/publications/DP3306 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Working Paper: Risk Aversion and Optimal Portfolio Policies in Partial and General Equilibrium Economies (2001)
Working Paper: Risk Aversion and Optimal Portfolio Policies in Partial and General Equilibrium Economies
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:3306

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP3306

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().