Consumption Risk, Preference Heterogeneity and Asset Prices
Goethe University Frankfurt - Research Center SAFE
Swiss Finance Institute; University of Lausanne - School of Economics and Business Administration (HEC-Lausanne)
September 1, 2012
This paper proposes a pure-exchange economy with three key ingredients: habit formation, stochastic moments of aggregate consumption, and a small degree of heterogeneity in risk aversion consistent with empirical data. We obtain closed formulas for many equilibrium quantities, including the moments of stock returns and individual portfolios. The proposed framework explains simultaneously the main features of stock returns – like cyclicality, persistence and predictability – as well as the counter-cyclical dynamics of the trading volume and its correlation with stock returns. In addition, we provide new testable implications concerning the dynamic behavior of the cross-sectional consumption/portfolio distribution over the business cycle.
Note: 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: 55
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 16, 2014
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