Asset Pricing with Heterogeneous Investors and Portfolio Constraints

Abstract:     
We study dynamic general equilibrium in a Lucas economies with one consumption good and two CRRA investors with heterogeneous risk aversions and beliefs about aggregate consumption growth rate, and portfolio constraints. We provide a tractable characterization of equilibrium without relying on the assumption of logarithmic constrained investors, popular in the literature, under which wealth-consumption ratios of these investors are unaffected by constraints. We explore the impact of borrowing, short-sale, and limited stock market participation constraints on market prices of risk, interest rates, stock return volatilities and price-dividend ratios. We demonstrate conditions under which constraints increase or decrease these equilibrium processes, and generate dynamic patterns consistent with empirical findings.

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

working papers series