Dynamic Equilibrium with Two Stocks, Heterogeneous Investors, and Portfolio Constraints

41 Pages Posted: 19 Feb 2013 Last revised: 20 Dec 2013

See all articles by Georgy Chabakauri

Georgy Chabakauri

London School of Economics and Political Science

Date Written: January 1, 2013

Abstract

We study dynamic general equilibrium in a Lucas economy with two trees, one consumption good, two CRRA investors with heterogeneous risk aversions, and portfolio constraints. We focus on margin and leverage constraints, which restrict access to credit markets. We find positive relationship between the amount of leverage in the economy and magnitudes of conditional stock return correlations and volatilities. Tighter constraints give rise to rich saddle-type patterns in correlations and volatilities, make them less countercyclical, increase risk premia proportionally to assets' margins, and increase price-dividend ratios of low-margin assets more than those of high-margin assets. The paper offers a new methodology for solving models with constraints, and derives closed-form solutions for the unconstrained case and the case of leverage constraints.

Keywords: asset pricing, dynamic equilibrium, heterogeneous investors, portfolio constraints, stochastic correlations, stock return volatility, consumption CAPM with constraints

JEL Classification: D52, G12

Suggested Citation

Chabakauri, Georgy, Dynamic Equilibrium with Two Stocks, Heterogeneous Investors, and Portfolio Constraints (January 1, 2013). Available at SSRN: https://ssrn.com/abstract=2221073 or http://dx.doi.org/10.2139/ssrn.2221073

Georgy Chabakauri (Contact Author)

London School of Economics and Political Science ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://personal.lse.ac.uk/CHABAKAU/

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