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The Market Price of Aggregate Risk and the Wealth Distribution

Hanno Lustig and YiLi Chien

No 11132, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We introduce limited liability in a model with a continuum of ex ante identical agents who face aggregate and idiosyncratic income risk. These agents can trade a complete menu of contingent claims, but they cannot commit and shares in a Lucas tree serve as collateral to back up their state-contingent promises. The limited liability option gives rise to a second risk factor, in addition to aggregate consumption growth risk. This liquidity risk is created by binding solvency constraints, and it is measured by the growth rate of one moment of the wealth distribution. The economy is said to experience a negative liquidity shock when this growth rate is high and a large fraction of agents faces severely binding solvency constraints. The adjustment to the Breeden-Lucas stochastic discount factor induces substantial time variation in equity risk premia that is consistent with the data at business cycle frequencies.

JEL-codes: G0 (search for similar items in EconPapers)
Date: 2005-02
New Economics Papers: this item is included in nep-cfn, nep-dge and nep-fin
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

Published as YiLi Chien & Hanno Lustig, 2010. "The Market Price of Aggregate Risk and the Wealth Distribution," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 23(4), pages 1596-1650, April.

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Journal Article: The Market Price of Aggregate Risk and the Wealth Distribution (2010) Downloads
Working Paper: The Market Price of Aggregate Risk and the Wealth Distribution (2004) Downloads
Working Paper: The Market Price of Aggregate Risk and the Wealth Distribution (2001) Downloads
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