Portfolio Rebalancing in General Equilibrium
39 Pages Posted: 22 Jul 2011
Date Written: July 7, 2011
Standard portfolio advice is that agents should hold a constant share of risky assets. All agents cannot, however, follow this advice because supply and demand of risky assets must be equal. To study equilibrium rebalancing, the paper develops an overlapping generations model in which agents differ both in age and risk tolerance. Equilibrium rebalancing is driven by a leverage effect that affects levered and unlevered agents in opposite directions, an aggregate risk tolerance effect which depends on the distribution of wealth, and an intertemporal hedging effect. Optimal equilibrium portfolio rebalancing departs significantly from the standard advice.
Keywords: rebalancing, portfolio theory, overlapping generations
JEL Classification: G11
Suggested Citation: Suggested Citation