Abstract

http://ssrn.com/abstract=1554741
 
 

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Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Re-Balancing?


YiLi Chien


Federal Reserve Bank of St. Louis

Harold L. Cole


University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Hanno N. Lustig


Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

April 23, 2010

American Economic Review, Forthcoming

Abstract:     
Our paper examines whether the well-documented failure of unsophisticated investors to rebalance their portfolios can help to explain the enormous counter-cyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up a model in which CRRA-utility investors have heterogeneous trading technologies. In our model, a large mass of investors do not re-balance their portfolio shares in response to aggregate shocks, while a smaller mass of active investors adjust their portfolio each period to respond to changes in the investment opportunity set. We find that these intermittent re-balancers amplify the effect of aggregate shocks on the time variation in risk premia by a factor of three by forcing active traders to sell more shares in good times and buy more shares in bad times.

Number of Pages in PDF File: 66

Keywords: Portfolio Rebalancing

JEL Classification: G12


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Date posted: February 18, 2010 ; Last revised: July 15, 2014

Suggested Citation

Chien, YiLi and Cole, Harold L. and Lustig, Hanno N., Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Re-Balancing? (April 23, 2010). American Economic Review, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1554741 or http://dx.doi.org/10.2139/ssrn.1554741

Contact Information

YiLi Chien
Federal Reserve Bank of St. Louis ( email )
P.O. Box 442
ST LOUIS, MO 63166
United States
314-444-4617 (Phone)
Harold L. Cole
University of Pennsylvania - Department of Economics ( email )
3718 Locust Walk
436 McNeil
Philadelphia, PA 19104
United States
215-898-7788 (Phone)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Hanno N. Lustig (Contact Author)
Stanford Graduate School of Business ( email )
Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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