Consumption Risk, Preference Heterogeneity and Asset Prices
Goethe University Frankfurt - Faculty of Economics and Business Administration
Swiss Finance Institute; University of Lausanne - School of Economics and Business Administration (HEC-Lausanne)
September 1, 2012
This paper analyses an exchange economy whose agents feature linear external habit and heterogeneous relative risk aversion. Aggregate consumption has stochastic moments in the affine class. Under a realistic pattern of heterogeneity, we derive closed forms for many equilibrium quantities, including the moments of stock returns and the optimal portfolios. We analytically characterize the role of habit, preference heterogeneity and time-varying exogenous uncertainty on the equilibrium price dynamics. These three ingredients help replicating various patterns of both conditional and unconditional moments of returns. Moreover we study the effect of habit and heterogeneity on individual portfolios and the resulting countercyclical trading volume.
An earlier version of this paper was circulated under the title: "Catching up with the Joneses under Preference Heterogeneity: An Exact Solution."
Number of Pages in PDF File: 52
Keywords: equilibrium asset pricing, heterogeneous preferences, external habit, portfolio strategies, closed form expression
JEL Classification: D51, D53, D83, G11, G12working papers series
Date posted: March 28, 2011 ; Last revised: October 4, 2012
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