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Heterogeneity in Preferences and Asset Market Outcomes

David A. Chapman
Boston College

Valery Polkovnichenko
University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

November 2006

Abstract:
We examine the impact of heterogeneity in preferences on asset prices in a setting where agents have rank-dependent expected utility. Endogenous limits to risk sharing arise naturally, with the more risk averse agents choosing to exit the market for the risky asset. This leads to economically significant variation in the equity premium and the risk free rate. Our results show that using a representative agent framework with non-expected utility preferences can be misleading precisely because it ignores these important endogenous risk sharing effects.

Keywords: Asset Prices, Aggregation, Rank-Dependent Expected Utility

JEL Classifications: G12

Working Paper Series

Date posted: January 21, 2005 ; Last revised: December 03, 2006

Suggested Citation

Chapman, David A. and Polkovnichenko, Valery, Heterogeneity in Preferences and Asset Market Outcomes (November 2006). Available at SSRN: http://ssrn.com/abstract=652085

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Contact Information

Valery Polkovnichenko (Contact Author) University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email ) 2601 North Floyd Road P.O. Box 830688 Richardson, TX 75083 United States HOME PAGE: http://www.utdallas.edu/~polkovn/
David A. Chapman Boston College ( email ) Carroll School of Management 140 Commonwealth Avenue Chestnut Hill, MA 02467-3808 United States 617.552.3989 (Phone) 617.552.0431 (Fax) HOME PAGE: http://www2.bc.edu/~chapmadb