66 Pages Posted: 18 Feb 2010 Last revised: 15 Jul 2014
Date Written: April 23, 2010
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 amplify the effect of aggregate shocks on the time variation in risk premia by a factor of three by forcing active traders to sell more shares in good times and buy more shares in bad times.
Keywords: Portfolio Rebalancing
JEL Classification: G12
Suggested Citation: 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 23, 2010). American Economic Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1554741 or http://dx.doi.org/10.2139/ssrn.1554741
By Andrew Abel