Asset Pricing with Heterogeneous Investors and Portfolio Constraints
London School of Economics and Political Science
April 1, 2013
We study general equilibrium in a Lucas (1978) economy with one consumption good and two investors with heterogeneous risk aversions and beliefs about aggregate consumption growth rate, and portfolio constraints. We provide a comprehensive comparison of various constraints, and show which of them and under what conditions help match the properties of asset prices in the data. We find that borrowing and short-sale constraints decrease stock return volatilities, whereas limited stock market participation constraints can increase volatilities even when investors have identical preferences and beliefs. Moreover, borrowing constraints generate spikes in interest rates and stock return volatilities when the constraint starts to bind. Finally, we find that short-sale constraints have smaller impact on asset prices than borrowing constraints, consistent with the empirical evidence on short-sale bans in the aftermath of 2007-09 financial crisis.
Number of Pages in PDF File: 36
Keywords: asset pricing, dynamic equilibrium, heterogeneous investors, borrowing constraints, short-sale constraints, limited participation constraints, stock return volatility
JEL Classification: D52, G12
Date posted: March 18, 2010 ; Last revised: December 9, 2014
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