53 Pages Posted: 14 Nov 2015 Last revised: 20 Jan 2017
Date Written: January 1, 2017
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: 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