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Capital Requirements and Asset Prices

53 Pages Posted: 14 Nov 2015 Last revised: 20 Jan 2017

Georgy Chabakauri

London School of Economics and Political Science

Brandon Yueyang Han

London School of Economics and Political Science

Date Written: January 1, 2017

Abstract

We consider a pure-exchange general equilibrium economy populated by investors with heterogeneous preferences and beliefs. The investors can potentially default on their risky positions unless these positions are backed by collateral. Each investor receives labor income, only fraction of which is pledgeable. We study the effects of a constraint that requires investors to keep their pledgeable financial capital above a certain threshold to provide sufficient collateral. We show that mere possibility of a crisis significantly decreases interest rates and increases Sharpe ratios. Constraints increase stock price-dividend ratios and generate spikes, crashes, and clustering of stock return volatilities. Stock price has a large liquidity premium over non-pledgeabile labor incomes. The equilibrium is stationary, and all investors survive in the long run. The asset prices are found in closed form.

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, Capital Requirements and Asset Prices (January 1, 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 and Political Science ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

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