Asset pricing with heterogeneous investors and portfolio constraints

Georgy Chabakauri

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We evaluate the impact of portfolio constraints on financial markets in a dynamic equilibrium pure exchange economy with one consumption good and two CRRA investors that may differ in risk aversions, beliefs regarding the dividend process and portfolio constraints. Despite numerous applications, portfolio constraints are notoriously difficult to incorporate into dynamic equilibrium analysis without the restrictive assumption of logarithmic preferences. We provide a tractable solution method that yields new insights on the asset pricing implications of portfolio constraints such as limited stock market participation, margin requirements and short sales prohibition without restricting risk aversion parameters. We demonstrate that in a setting where one investor is unconstrained while the other faces an upper bound constraint on the proportion of wealth that can be invested in stocks the model generates countercyclical market prices of risk and stock return volatilities, procyclical price-dividend ratios, excess volatility and other patterns consistent with empirical findings. In a setting with margin requirements we demonstrate that under plausible parameters tighter constraints decrease stock return volatilities during the times when the constraints are likely to bind.

Keywords: asset pricing; dynamic equilibrium; heterogeneous investors; portfolio constraints; stock return volatility (search for similar items in EconPapers)
JEL-codes: D52 G12 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2010-03-15
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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