Collateral Requirements and Asset Prices
58 Pages Posted: 14 Nov 2015 Last revised: 17 Apr 2018
Date Written: April 4, 2018
We consider an 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 capital to cover their liabilities. We show that these constraints inflate stock prices, give rise to clusters of stock return volatilities, and produce spikes and crashes in price-dividend ratios and volatilities. Furthermore, mere possibility of a crisis significantly decreases interest rates and increases Sharpe ratios. The stock price has large collateral premium over non-pledgeable incomes. Asset prices are in closed form, and 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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