Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Re-Balancing?

53 Pages Posted: 16 Sep 2009 Last revised: 11 May 2015

YiLi Chien

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Harold L. Cole

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Hanno N. Lustig

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: April 30, 2010

Abstract

Our paper examines whether the well-documented failure of unsophisticated investors to rebalance their portfolios can help to explain the enormous counter-cyclical volatility of aggregate risk compensation in financial markets. To answer this question, we set up a model in which CRRA-utility investors have heterogeneous trading technologies. In our model, a large mass of investors do not re-balance their portfolio shares in response to aggregate shocks, while a smaller mass of active investors adjust their portfolio each period to respond to changes in the investment opportunity set. We find that these intermittent re-balancers more than double the effect of aggregate shocks on the time variation in risk premia by forcing active traders to sell more shares in good times and buy more shares in bad times.

Keywords: Asset Pricing, Household Finance, Risk Sharing, Limited Participation

JEL Classification: G12

Suggested Citation

Chien, YiLi and Cole, Harold L. and Lustig, Hanno N., Is the Volatility of the Market Price of Risk Due to Intermittent Portfolio Re-Balancing? (April 30, 2010). American Economic Review, Vol. 102, No. 6, 2012. Available at SSRN: https://ssrn.com/abstract=1473520 or http://dx.doi.org/10.2139/ssrn.1473520

YiLi Chien

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Harold L. Cole

University of Pennsylvania - Department of Economics ( email )

3718 Locust Walk
436 McNeil
Philadelphia, PA 19104
United States
215-898-7788 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Hanno N. Lustig (Contact Author)

Stanford Graduate School of Business ( email )

Stanford GSB
655 Knight Way
Stanford, CA California 94305-6072
United States
3108716532 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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