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Collateral Requirements and Asset Prices

55 Pages Posted: 14 Nov 2015 Last revised: 30 Nov 2017

Georgy Chabakauri

London School of Economics and Political Science

Brandon Yueyang Han

London School of Economics & Political Science, Department of Finance

Date Written: October 14, 2017

Abstract

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

Suggested Citation

Chabakauri, Georgy and Han, Brandon Yueyang, Collateral Requirements and Asset Prices (October 14, 2017). Paris December 2016 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2689672 or http://dx.doi.org/10.2139/ssrn.2689672

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/

Brandon Yueyang Han

London School of Economics & Political Science, Department of Finance ( email )

London
Great Britain

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