Asset Prices with Heterogeneous Loss Averse Investors

44 Pages Posted: 21 Jun 2012 Last revised: 1 Nov 2012

See all articles by Giuliano Curatola

Giuliano Curatola

University of Siena - Department of Economics and Statistics; Leibniz Institute for Financial Research SAFE

Date Written: October 30, 2012

Abstract

This paper considers a general-equilibrium model with loss-aversion in consumption and heterogeneity: there is a continuum of agents, with s-shaped utility, who differ in the time-varying reference level of consumption. Heterogeneity in the reference level is crucial for the existence of the equilibrium, which cannot be obtained with a representative agent or a discrete number of agents. Loss-aversion in consumption induces a kink in the pricing kernel and consequently, jumps in the market price of risk, stock return, and volatility. An economy populated with only loss-averse agents produces one counter-factual property of asset price: the return volatility and the market price of risk are higher in good times than in bad times. The coexistence of both loss-averse and risk-averse agents in the economy helps fixing this undesirable property and also explains the dynamics of trading volume and its correlation with asset prices.

Keywords: equilibrium, heterogeneity, loss aversion, local time, trading volume

JEL Classification: G11, G12

Suggested Citation

Curatola, Giuliano, Asset Prices with Heterogeneous Loss Averse Investors (October 30, 2012). Available at SSRN: https://ssrn.com/abstract=2088763 or http://dx.doi.org/10.2139/ssrn.2088763

Giuliano Curatola (Contact Author)

University of Siena - Department of Economics and Statistics ( email )

Piazza San Francesco 7
Siena, Siena 53100
Italy

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

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