A Multiplier Approach to Understanding the Macro Implications of Household Finance

YiLi Chien, Harold Cole and Hanno Lustig

No 13555, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Our paper examines the impact of heterogeneous trading technologies for households on asset prices and the distribution of wealth. We distinguish between passive traders who hold fixed portfolios of stocks and bonds, and active traders who adjust their portfolios to changes in expected returns. To solve the model, we derive an optimal consumption sharing rule that does not depend on the trading technology, and we derive an aggregation result for state prices. This allows us to solve for equilibrium prices and allocations without having to search for market-clearing prices in each asset market separately. We show that the fraction of total wealth held by active traders, not the fraction held by all participants, is critical for asset prices, because only these traders respond to variation in state prices and hence absorb the residual aggregate risk created by non-participants. We calibrate the heterogeneity in trading technologies to match the equity premium and the risk-free rate. The calibrated model reproduces the skewness and kurtosis of the wealth distribution in the data. In contrast to existing models with heterogeneous agents, our model matches the high volatility of returns and the low volatility of the risk-free rate.

JEL-codes: G12 (search for similar items in EconPapers)
Date: 2007-11
New Economics Papers: this item is included in nep-dge
Note: AP EFG
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Citations: View citations in EconPapers (12)

Published as Yili Chien & Harold Cole & Hanno Lustig, 2011. "A Multiplier Approach to Understanding the Macro Implications of Household Finance," Review of Economic Studies, Oxford University Press, vol. 78(1), pages 199-234.

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