Micro Frictions, Asset Pricing and Aggregate

Jack Favilukis and Xiaoji Lin

FMG Discussion Papers from Financial Markets Group

Abstract: We use asset pricing insights to study importance of micro-level frictions for aggregate quantities. In our model, the relevant stochastic variable is a stationary growth rate (necessary to produce high Sharpe Ratios in a Long Run Risk world), as opposed to a trend-stationary level of productivity. This naturally implies a heteroscedastic and timedependent aggregate investment rate; contributing to the recent debate between Khan and Thomas (2008) and Bachmann, Caballero, and Engel (2010), we find that non-convex costs are not necessary to match these moments. Our best model, combining convex and nonconvex costs, matches aggregate macro-economic and micro-level investment moments, as well as the High Sharpe Ratio of equity.

Date: 2011-02
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