Collateral Requirements and Asset Prices
55 Pages Posted: 14 Nov 2015 Last revised: 30 Nov 2017
Date Written: October 14, 2017
We consider a pure-exchange general equilibrium economy populated by investors with heterogeneous preferences and beliefs who receive non-pledgeable labor incomes. We study the effects of collateral constraints that require investors to maintain sufficient pledgeable financial capital to cover their liabilities such as debt and short positions on financial assets. We show that these constraints inflate stock prices, lead to the clustering of stock return volatilities, and produce spikes and crashes in price-dividend ratios and stock return volatilities. Furthermore, mere possibility of a crisis significantly decreases interest rates and increases Sharpe ratios. Stock price has a large collateral premium over non-pledgeable incomes. The equilibrium processes for asset prices are stationary and available in closed form, and all investors survive in the long run.
Keywords: collateral, non-pledgeable labor income, heterogeneous preferences, disagreement, asset prices, stationary equilibrium
JEL Classification: D52, G12
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